Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2017
or
¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File Number: 0-18415
 
Isabella Bank Corporation
(Exact name of registrant as specified in its charter)
 
Michigan
 
38-2830092
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
401 N. Main St, Mt. Pleasant, MI
 
48858
(Address of principal executive offices)
 
(Zip code)
(989) 772-9471
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ý  Yes    ¨  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ý  Yes    ¨  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
 
Accelerated filer
 
ý
 
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
 
 
 
 
 
 
 
 
 
Emerging growth company
 
¨
 
 
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     ¨  Yes    ý  No
The number of common shares outstanding of the registrant’s Common Stock (no par value) was 7,853,629 as of October 31, 2017.


Table of Contents

ISABELLA BANK CORPORATION
QUARTERLY REPORT ON FORM 10-Q
Table of Contents
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 1A.
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
Item 5.
 
 
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 
 
 
 

2

Table of Contents

Forward Looking Statements
This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward looking statements to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, and are included in this statement for purposes of these safe harbor provisions. Forward looking statements, which are based on certain assumptions and describe future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, monetary and fiscal policy, the quality or composition of the loan or investment portfolios, demand for loan products, fluctuation in the value of collateral securing our loan portfolio, deposit flows, competition, demand for financial services in our market area, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward looking statements and undue reliance should not be placed on such statements. Further information concerning our business, including additional factors that could materially affect our financial results, is included in our filings with the SEC.
Glossary of Acronyms and Abbreviations
The acronyms and abbreviations identified below may be used throughout this Quarterly Report on Form 10-Q, or in our other SEC filings. You may find it helpful to refer back to this page while reading this report.
AFS: Available-for-sale
 
GAAP: U.S. generally accepted accounting principles
ALLL: Allowance for loan and lease losses
 
GLB Act: Gramm-Leach-Bliley Act of 1999
AOCI: Accumulated other comprehensive income
 
IFRS: International Financial Reporting Standards
ASC: FASB Accounting Standards Codification
 
IRR: Interest rate risk
ASU: FASB Accounting Standards Update
 
ISDA: International Swaps and Derivatives Association
ATM: Automated Teller Machine
 
JOBS Act: Jumpstart our Business Startups Act
BHC Act: Bank Holding Company Act of 1956
 
LIBOR: London Interbank Offered Rate
CFPB: Consumer Financial Protection Bureau
 
N/A: Not applicable
CIK: Central Index Key
 
N/M: Not meaningful
CRA: Community Reinvestment Act
 
NASDAQ: NASDAQ Stock Market Index
DIF: Deposit Insurance Fund
 
NASDAQ Banks: NASDAQ Bank Stock Index
DIFS: Department of Insurance and Financial Services
 
NAV: Net asset value
Directors Plan: Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors
 
NOW: Negotiable order of withdrawal
Dividend Reinvestment Plan: Isabella Bank Corporation Stockholder Dividend Reinvestment Plan and Employee Stock Purchase Plan
 
NSF: Non-sufficient funds
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
 
OCI: Other comprehensive income (loss)
ESOP: Employee Stock Ownership Plan
 
OMSR: Originated mortgage servicing rights
Exchange Act: Securities Exchange Act of 1934
 
OREO: Other real estate owned
FASB: Financial Accounting Standards Board
 
OTTI: Other-than-temporary impairment
FDI Act: Federal Deposit Insurance Act
 
PBO: Projected benefit obligation
FDIC: Federal Deposit Insurance Corporation
 
PCAOB: Public Company Accounting Oversight Board
FFIEC: Federal Financial Institutions Examinations Council
 
Rabbi Trust: A trust established to fund the Directors Plan
FRB: Federal Reserve Bank
 
SEC: U.S. Securities and Exchange Commission
FHLB: Federal Home Loan Bank
 
SOX: Sarbanes-Oxley Act of 2002
Freddie Mac: Federal Home Loan Mortgage Corporation
 
TDR: Troubled debt restructuring
FTE: Fully taxable equivalent
 
XBRL: eXtensible Business Reporting Language

3

Table of Contents

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements.
INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Dollars in thousands)

September 30
2017
 
December 31
2016
ASSETS
 
 
 
Cash and cash equivalents
 
 
 
Cash and demand deposits due from banks
$
20,650

 
$
20,167

Interest bearing balances due from banks
417

 
2,727

Total cash and cash equivalents
21,067

 
22,894

AFS securities (amortized cost of $548,468 in 2017 and $557,648 in 2016)
552,925

 
558,096

Mortgage loans AFS
1,237

 
1,816

Loans
 
 
 
Commercial
620,135

 
575,664

Agricultural
132,998

 
126,492

Residential real estate
271,480

 
266,050

Consumer
52,931

 
42,409

Gross loans
1,077,544

 
1,010,615

Less allowance for loan and lease losses
7,700

 
7,400

Net loans
1,069,844

 
1,003,215

Premises and equipment
28,761

 
29,314

Corporate owned life insurance policies
26,837

 
26,300

Accrued interest receivable
7,388

 
6,580

Equity securities without readily determinable fair values
23,461

 
21,694

Goodwill and other intangible assets
48,575

 
48,666

Other assets
11,872

 
13,576

TOTAL ASSETS
$
1,791,967

 
$
1,732,151

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits
 
 
 
Noninterest bearing
$
212,608

 
$
205,071

NOW accounts
220,601

 
209,325

Certificates of deposit under $250 and other savings
723,834

 
717,078

Certificates of deposit over $250
59,019

 
63,566

Total deposits
1,216,062

 
1,195,040

Borrowed funds
367,027

 
337,694

Accrued interest payable and other liabilities
12,415

 
11,518

Total liabilities
1,595,504

 
1,544,252

Shareholders’ equity
 
 
 
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,856,664 shares (including 28,547 shares held in the Rabbi Trust) in 2017 and 7,821,069 shares (including 26,042 shares held in the Rabbi Trust) in 2016
140,368

 
139,525

Shares to be issued for deferred compensation obligations
5,364

 
5,038

Retained earnings
50,680

 
46,114

Accumulated other comprehensive income (loss)
51

 
(2,778
)
Total shareholders’ equity
196,463

 
187,899

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,791,967

 
$
1,732,151




See notes to interim condensed consolidated financial statements (unaudited).

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Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Dollars in thousands except per share amounts)

Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30
 
2017
 
2016
 
2017
 
2016
Interest income
 
 
 
 
 
 
 
Loans, including fees
$
11,297

 
$
9,965

 
$
32,102

 
$
28,320

AFS securities
 
 
 
 
 
 
 
Taxable
2,075

 
2,037

 
6,452

 
6,740

Nontaxable
1,406

 
1,411

 
4,234

 
4,337

Federal funds sold and other
198

 
194

 
547

 
509

Total interest income
14,976

 
13,607

 
43,335

 
39,906

Interest expense
 
 
 
 
 
 
 
Deposits
1,715

 
1,496

 
4,870

 
4,313

Borrowings
1,485

 
1,251

 
4,189

 
3,726

Total interest expense
3,200

 
2,747

 
9,059

 
8,039

Net interest income
11,776

 
10,860

 
34,276

 
31,867

Provision for loan losses
49

 
17

 
85

 
185

Net interest income after provision for loan losses
11,727

 
10,843

 
34,191

 
31,682

Noninterest income
 
 
 
 
 
 
 
Service charges and fees
1,435

 
1,276

 
4,370

 
3,652

Net gain on sale of mortgage loans
153

 
263

 
507

 
472

Earnings on corporate owned life insurance policies
174

 
183

 
537

 
566

Net gains on sale of AFS securities

 

 
142

 
245

Other
936

 
1,224

 
2,546

 
2,986

Total noninterest income
2,698

 
2,946

 
8,102

 
7,921

Noninterest expenses
 
 
 
 
 
 
 
Compensation and benefits
5,360

 
4,940

 
15,869

 
14,412

Furniture and equipment
1,377

 
1,353

 
4,073

 
3,988

Occupancy
809

 
845

 
2,461

 
2,443

Other
2,593

 
2,295

 
7,194

 
6,888

Total noninterest expenses
10,139

 
9,433

 
29,597

 
27,731

Income before federal income tax expense
4,286

 
4,356

 
12,696

 
11,872

Federal income tax expense
750

 
763

 
2,180

 
1,855

NET INCOME
$
3,536

 
$
3,593

 
$
10,516

 
$
10,017

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.45

 
$
0.46

 
$
1.34

 
$
1.28

Diluted
$
0.44

 
$
0.45

 
$
1.31

 
$
1.25

Cash dividends per common share
$
0.26

 
$
0.25

 
$
0.76

 
$
0.73







See notes to interim condensed consolidated financial statements (unaudited).

5

Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(Dollars in thousands)

Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30
 
2017
 
2016
 
2017
 
2016
Net income
$
3,536

 
$
3,593

 
$
10,516

 
$
10,017

Unrealized gains (losses) on AFS securities
 
 
 
 
 
 
 
Unrealized gains (losses) on AFS securities arising during the period
(96
)
 
(2,548
)
 
4,151

 
8,793

Reclassification adjustment for net realized (gains) losses included in net income

 

 
(142
)
 
(245
)
Tax effect (1)
54

 
937

 
(1,158
)
 
(2,713
)
Unrealized gains (losses) on AFS securities, net of tax
(42
)
 
(1,611
)
 
2,851

 
5,835

Unrealized gains (losses) on derivative instruments arising during the period
11

 
91

 
(33
)
 
(61
)
Tax effect (1)
(4
)
 
(31
)
 
11

 
21

Unrealized gains (losses) on derivative instruments, net of tax
7

 
60

 
(22
)
 
(40
)
Other comprehensive income, net of tax
(35
)
 
(1,551
)
 
2,829

 
5,795

Comprehensive income
$
3,501

 
$
2,042

 
$
13,345

 
$
15,812

(1) 
See “Note 12 – Accumulated Other Comprehensive Income” for tax effect reconciliation.



















See notes to interim condensed consolidated financial statements (unaudited).

6

Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)
(Dollars in thousands except per share amounts)
 
Common Stock
 
 
 
 
 
 
 
 

Common Shares
Outstanding
 
Amount
 
Common Shares to be
Issued for
Deferred
Compensation
Obligations
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Totals
Balance, January 1, 2016
7,799,867

 
$
139,198

 
$
4,592

 
$
39,960

 
$
221

 
$
183,971

Comprehensive income (loss)

 

 

 
10,017

 
5,795

 
15,812

Issuance of common stock
131,697

 
3,683

 

 

 

 
3,683

Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations

 
127

 
(127
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
443

 

 

 
443

Common stock purchased for deferred compensation obligations

 
(279
)
 

 

 

 
(279
)
Common stock repurchased pursuant to publicly announced repurchase plan
(98,083
)
 
(2,749
)
 

 

 

 
(2,749
)
Cash dividends paid ($0.73 per common share)

 

 

 
(5,697
)
 

 
(5,697
)
Balance, September 30, 2016
7,833,481

 
$
139,980

 
$
4,908

 
$
44,280

 
$
6,016

 
$
195,184

Balance, January 1, 2017
7,821,069

 
$
139,525

 
$
5,038

 
$
46,114

 
$
(2,778
)
 
$
187,899

Comprehensive income (loss)

 

 

 
10,516

 
2,829

 
13,345

Issuance of common stock
178,712

 
4,999

 

 

 

 
4,999

Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations

 
176

 
(176
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
502

 

 

 
502

Common stock purchased for deferred compensation obligations

 
(327
)
 

 

 

 
(327
)
Common stock repurchased pursuant to publicly announced repurchase plan
(143,117
)
 
(4,005
)
 

 

 

 
(4,005
)
Cash dividends paid ($0.76 per common share)

 

 

 
(5,950
)
 

 
(5,950
)
Balance, September 30, 2017
7,856,664

 
$
140,368

 
$
5,364

 
$
50,680

 
$
51

 
$
196,463















See notes to interim condensed consolidated financial statements (unaudited).

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Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Dollars in thousands)

Nine Months Ended 
 September 30
 
2017
 
2016
OPERATING ACTIVITIES
 
 
 
Net income
$
10,516

 
$
10,017

Reconciliation of net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
85

 
185

Impairment of foreclosed assets
2

 

Depreciation
2,163

 
2,116

Amortization of OMSR
257

 
299

Amortization of acquisition intangibles
91

 
128

Net amortization of AFS securities
1,614

 
2,115

Net (gains) losses on sale of AFS securities
(142
)
 
(245
)
Net gain on sale of mortgage loans
(507
)
 
(472
)
Increase in cash value of corporate owned life insurance policies
(537
)
 
(566
)
Share-based payment awards under equity compensation plan
502

 
443

Origination of loans held-for-sale
(28,436
)
 
(22,994
)
Proceeds from loan sales
29,522

 
23,968

Net changes in operating assets and liabilities which provided (used) cash:
 
 
 
Accrued interest receivable
(808
)
 
(599
)
Other assets
(1,491
)
 
1,005

Accrued interest payable and other liabilities
897

 
165

Net cash provided by (used in) operating activities
13,728

 
15,565

INVESTING ACTIVITIES
 
 
 
Activity in AFS securities
 
 
 
Sales
12,827

 
35,664

Maturities, calls, and principal payments
78,352

 
111,543

Purchases
(83,471
)
 
(44,622
)
Net loan principal (originations) collections
(66,928
)
 
(138,870
)
Proceeds from sales of foreclosed assets
203

 
348

Purchases of premises and equipment
(1,610
)
 
(2,771
)
Proceeds from redemption of corporate owned life insurance policies

 
1,004

Net cash provided by (used in) investing activities
(60,627
)
 
(37,704
)

8

Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
 
Nine Months Ended 
 September 30
 
2017
 
2016
FINANCING ACTIVITIES
 
 
 
Net increase (decrease) in deposits
$
21,022

 
$
11,270

Net increase (decrease) in borrowed funds
29,333

 
15,677

Cash dividends paid on common stock
(5,950
)
 
(5,697
)
Proceeds from issuance of common stock
4,999

 
3,683

Common stock repurchased
(4,005
)
 
(2,749
)
Common stock purchased for deferred compensation obligations
(327
)
 
(279
)
Net cash provided by (used in) financing activities
45,072

 
21,905

Increase (decrease) in cash and cash equivalents
(1,827
)
 
(234
)
Cash and cash equivalents at beginning of period
22,894

 
21,569

Cash and cash equivalents at end of period
$
21,067

 
$
21,335

SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Interest paid
$
9,000

 
$
8,042

Income taxes paid
$
2,470

 
$
1,350

SUPPLEMENTAL NONCASH INFORMATION:
 
 
 
Transfers of loans to foreclosed assets
$
214

 
$
211























See notes to interim condensed consolidated financial statements (unaudited).

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Table of Contents

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Dollars in thousands except per share amounts)
Note 1 – Basis of Presentation
As used in these notes, as well as in Management's Discussion and Analysis of Financial Condition and Results of Operations, references to “Isabella,” the “Corporation”, “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiaries. Isabella Bank Corporation refers solely to the parent holding company, and Isabella Bank or the “Bank” refer to Isabella Bank Corporation’s subsidiary, Isabella Bank.
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2016.
Our accounting policies are materially the same as those discussed in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2016.
Reclassifications: Certain amounts reported in the interim 2016 consolidated financial statements have been reclassified to conform with the 2017 presentation.
Note 2 – Computation of Earnings Per Common Share
Basic earnings per common share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued relate solely to outstanding shares in the Directors Plan.
 
Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30

2017
 
2016
 
2017
 
2016
Average number of common shares outstanding for basic calculation
7,848,317

 
7,824,751

 
7,839,172

 
7,813,084

Average potential effect of common shares in the Directors Plan (1)
192,572

 
186,667

 
191,548

 
184,996

Average number of common shares outstanding used to calculate diluted earnings per common share
8,040,889

 
8,011,418

 
8,030,720

 
7,998,080

Net income
$
3,536

 
$
3,593

 
$
10,516

 
$
10,017

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.45

 
$
0.46

 
$
1.34

 
$
1.28

Diluted
$
0.44

 
$
0.45

 
$
1.31

 
$
1.25

(1) 
Exclusive of shares held in the Rabbi Trust
Note 3 – Accounting Standards Updates
Pending Accounting Standards Updates
ASU No. 2014-09: “Revenue from Contracts with Customers”
In May 2014, ASU No. 2014-09 created new Topic 606 to provide a common revenue standard to achieve consistency and clarification to the revenue recognition principles. The guidance outlines steps to achieve the core principle which states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. These steps consist of: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation.

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Table of Contents

The new authoritative guidance was originally effective on January 1, 2017; however, ASU 2015-14 was issued which deferred the effective date of ASU 2014-09 by one year to January 1, 2018. The majority of our income, as well as that of the vast majority of financial institutions, is excluded from this guidance. We are reviewing our contracts related to trust and investment services and those related to other noninterest income to determine if changes in income recognition is required as a result of this guidance. While we anticipate some change as a result of implementing this guidance, we do not expect it to have a significant impact on our operating results or financial statement disclosures.
ASU No. 2016-02: “Leases (Topic 842)”
In February 2016, ASU No. 2016-02 was issued to create Topic 842 - Leases which will require recognition of lease assets and lease liabilities on the balance sheet for leases previously classified as operating leases. Accounting guidance is set forth for both lessee and lessor accounting. Under lessee accounting, a lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.
For finance leases, a lessee is required to do the following: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position; 2) recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of comprehensive income; and 3) classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows. For operating leases, a lessee is required to do the following: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position; 2) recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis; and 3) classify all cash payments within operating activities in the statement of cash flows.
The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2018. We have and will continue to review our lease agreements to determine the appropriate treatment under this guidance. We do not expect these changes to have a significant impact on our operating results or financial statement disclosures.
ASU No. 2017-09: Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting”
In May 2017, ASU No. 2017-09 provided guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting under Topic 718. The current disclosure requirements in Topic 718 apply regardless of whether an entity is required to apply modification accounting under the amendments in this update. An entity should account for the effects of a modification unless all of the following are met:
1. The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification.
2. The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified.
3. The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified.
The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2017 and is not expected to have a significant impact on our operating results or financial statement disclosures.
ASU No. 2017-12: Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities”
In August 2017, ASU No. 2017-12 was issued to improve financial reporting of hedging activities to better portray the economic results of an entity’s risk management activities. The update provides changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results.

The update addresses current GAAP designation limitations by permitting hedge accounting for risk components in hedging relationships involving nonfinancial risk and interest rate risk as follows:
1. For a cash flow hedge of a forecasted purchase or sale of a nonfinancial asset, an entity could designate as the hedged risk the variability in cash flows attributable to changes in a contractually specified component stated in the contract. The amendments remove the requirement in current GAAP that only the overall variability in cash flows or variability related to foreign currency risk could be designated as the hedged risk in a cash flow hedge of a nonfinancial asset.

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2. For a cash flow hedge of interest rate risk of a variable-rate financial instrument, an entity could designate as the hedged risk the variability in cash flows attributable to the contractually specified interest rate. By eliminating the concept of benchmark interest rates for hedges of variable-rate instruments in current GAAP, the amendments remove the requirement to designate only the overall variability in cash flows as the hedged risk in a cash flow hedge of a variable-rate instrument indexed to a non-benchmark interest rate.
3. For a fair value hedge of interest rate risk, the amendments add the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate as an eligible benchmark interest rate in the United States in addition to those already permitted under current GAAP (the U.S. Treasury Rate, the London Interbank Offered Rate [LIBOR] Swap Rate, and the Fed Funds Effective Swap Rate [or Overnight Index Swap Rate]). This allows an entity that issues or invests in fixed-rate tax-exempt financial instruments to designate as the hedged risk changes in fair value attributable to interest rate risk related to the SIFMA Municipal Swap Rate rather than overall changes in fair value.
The amendments in this update provide further revisions to the current limitations on designation in a fair value hedge of interest rate risk. Specifically, the update changes the guidance for designating fair value hedges of interest rate risk and for measuring the change in fair value of the hedged item in fair value hedges of interest rate risk by providing four permissible accounting treatments.
In addition to the amendments to the designation and measurement guidance for qualifying hedging relationships, the amendments in this update also align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. The following recognition and presentation guidance for qualifying hedges is required:
1. For fair value hedges, the entire change in the fair value of the hedging instrument included in the assessment of hedge effectiveness is presented in the same income statement line that is used to present the earnings effect of the hedged item. The timing of recognition of the change in fair value of a hedging instrument included in the assessment of hedge effectiveness is the same as under current GAAP, but the presentation of hedge results could change because current GAAP does not specify a required presentation of the change in fair value of the hedging instrument.
2. For cash flow and net investment hedges, the entire change in the fair value of the hedging instrument included in the assessment of hedge effectiveness is recorded in other comprehensive income (for cash flow hedges) or in the currency translation adjustment section of other comprehensive income (for net investment hedges). Those amounts are reclassified to earnings in the same income statement line item that is used to present the earnings effect of the hedged item when the hedged
item affects earnings. The timing of recognition of the change in fair value of a hedging instrument could change relative to current GAAP because hedge ineffectiveness no longer is recognized in current period earnings. The presentation of hedge results also could change because current GAAP does not specify a required presentation of the change in fair value of the hedging instrument in the income statement.
Lastly, the guidance within this update provides exclusions from the hedge effectiveness assessment and five other targeted improvements to current guidance also related to the assessment of hedge effectiveness. Excluding option premiums and forward points will still be permissible under the new guidance. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2018 and is not expected to have a significant impact on our operating results or financial statement disclosures.

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Note 4 – AFS Securities
The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:
 
September 30, 2017

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
231

 
$
1

 
$

 
$
232

States and political subdivisions
207,874

 
5,596

 
13

 
213,457

Auction rate money market preferred
3,200

 

 
28

 
3,172

Preferred stocks
3,800

 

 
149

 
3,651

Mortgage-backed securities
216,684

 
860

 
1,630

 
215,914

Collateralized mortgage obligations
116,679

 
600

 
780

 
116,499

Total
$
548,468

 
$
7,057

 
$
2,600

 
$
552,925

 
December 31, 2016

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
10,258

 
$
3

 
$
2

 
$
10,259

States and political subdivisions
208,977

 
4,262

 
320

 
212,919

Auction rate money market preferred
3,200

 

 
406

 
2,794

Preferred stocks
3,800

 

 
375

 
3,425

Mortgage-backed securities
229,593

 
581

 
2,918

 
227,256

Collateralized mortgage obligations
101,820

 
600

 
977

 
101,443

Total
$
557,648

 
$
5,446

 
$
4,998

 
$
558,096

The amortized cost and fair value of AFS securities by contractual maturity at September 30, 2017 are as follows:
 
Maturing
 
Securities with Variable Monthly Payments or Noncontractual Maturities
 
 

Due in
One Year
or Less
 
After One
Year But
Within
Five Years
 
After Five
Years But
Within
Ten Years
 
After
Ten Years
 
 
Total
Government sponsored enterprises
$

 
$
231

 
$

 
$

 
$

 
$
231

States and political subdivisions
25,689

 
73,810

 
75,598

 
32,777

 

 
207,874

Auction rate money market preferred

 

 

 

 
3,200

 
3,200

Preferred stocks

 

 

 

 
3,800

 
3,800

Mortgage-backed securities

 

 

 

 
216,684

 
216,684

Collateralized mortgage obligations

 

 

 

 
116,679

 
116,679

Total amortized cost
$
25,689

 
$
74,041

 
$
75,598

 
$
32,777

 
$
340,363

 
$
548,468

Fair value
$
25,746


$
76,105


$
78,383


$
33,455


$
339,236

 
$
552,925

Expected maturities for government sponsored enterprises and states and political subdivisions may differ from contractual maturities because issuers may have the right to call or prepay obligations.
As the auction rate money market preferred and preferred stocks have continual call dates, they are not reported by a specific maturity group. Because of their variable monthly payments, mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group.

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A summary of the sales activity of AFS securities was as follows for the:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2017
 
2016
 
2017
 
2016
Proceeds from sales of AFS securities
$

 
$

 
$
12,827

 
$
35,664

Gross realized gains (losses)
$

 
$

 
$
142

 
$
245

Applicable income tax expense (benefit)
$

 
$

 
$
48

 
$
83

The following information pertains to AFS securities with gross unrealized losses at September 30, 2017 and December 31, 2016, aggregated by investment category and length of time that individual securities have been in a continuous loss position.
 
September 30, 2017
 
Less Than Twelve Months
 
Twelve Months or More
 
 

Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total
Unrealized
Losses
Government sponsored enterprises
$

 
$

 
$

 
$

 
$

States and political subdivisions
12

 
3,321

 
1

 
221

 
13

Auction rate money market preferred

 

 
28

 
3,172

 
28

Preferred stocks

 

 
149

 
3,651

 
149

Mortgage-backed securities
1,277

 
106,229

 
353

 
12,777

 
1,630

Collateralized mortgage obligations
331

 
33,969

 
449

 
15,303

 
780

Total
$
1,620

 
$
143,519

 
$
980

 
$
35,124

 
$
2,600

Number of securities in an unrealized loss position:
 
 
35

 
 
 
13

 
48

 
December 31, 2016
 
Less Than Twelve Months
 
Twelve Months or More
 
 

Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total
Unrealized
Losses
Government sponsored enterprises
$
2

 
$
9,936

 
$

 
$

 
$
2

States and political subdivisions
311

 
21,800

 
9

 
355

 
320

Auction rate money market preferred

 

 
406

 
2,794

 
406

Preferred stocks

 

 
375

 
3,425

 
375

Mortgage-backed securities
2,918

 
175,212

 

 

 
2,918

Collateralized mortgage obligations
628

 
51,466

 
349

 
11,381

 
977

Total
$
3,859

 
$
258,414

 
$
1,139

 
$
17,955

 
$
4,998

Number of securities in an unrealized loss position:
 
 
104

 
 
 
9

 
113

As of September 30, 2017 and December 31, 2016, we conducted an analysis to determine whether any AFS securities currently in an unrealized loss position should be other-than-temporarily impaired. Such analyses considered, among other factors, the following criteria:
Has the value of the investment declined more than what is deemed to be reasonable based on a risk and maturity adjusted discount rate?
Is the investment credit rating below investment grade?
Is it probable the issuer will be unable to pay the amount when due?
Is it more likely than not that we will have to sell the security before recovery of its cost basis?
Has the duration of the investment been extended?
During the fourth quarter of 2016, we identified one municipal bond as other-than-temporarily impaired. While management estimated the OTTI to be realized, we also engaged the services of an independent investment valuation firm to estimate the amount of impairment as of December 31, 2016. The valuation calculated the estimated market value utilizing two different approaches:
1) Market - Appraisal and Comparable Investments
2) Income - Discounted Cash Flow Method

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The two methods were then weighted, with a higher weighting applied to the Market approach, to determine the estimated impairment. As a result of this analysis, we recognized an OTTI of $770 in earnings for the year ended December 31, 2016. Based on analysis of this bond, there was no additional OTTI recognized as of September 30, 2017.
Based on our analysis which included the criteria outlined above, the fact that we have asserted that we do not have the intent to sell AFS securities in an unrealized loss position, and considering it is unlikely that we will have to sell any AFS securities in an unrealized loss position before recovery of their cost basis, we do not believe that the values of any other AFS securities are other-than-temporarily impaired as of September 30, 2017 or December 31, 2016, with the exception of the one municipal bond discussed above.
Note 5 – Loans and ALLL
We grant commercial, agricultural, residential real estate, and consumer loans to customers situated primarily in Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties in Michigan. The ability of the borrowers to honor their repayment obligations is often dependent upon the real estate, agricultural, manufacturing, retail, gaming, tourism, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees. A portion of loans are unsecured.
Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and any deferred fees or costs. Interest income is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the level yield method.
The accrual of interest on commercial, agricultural, and residential real estate loans is discontinued at the time the loan is 90 days or more past due unless the credit is well-secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful.
For loans that are placed on nonaccrual status or charged-off, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the ALLL. Loans may be returned to accrual status after six months of continuous performance and achievement of current payment status.
Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, advances to mortgage brokers, farmland and agricultural production, and states and political subdivisions. Repayment of these loans is dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of direct credit exposure to any one borrower to $15,000. Borrowers with direct credit needs of more than $15,000 are serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans commonly require loan-to-value limits of 80% or less. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, and property and equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we require annual financial statements, prepare cash flow analyses, and review credit reports.
We entered into a mortgage purchase program in 2016 with a financial institution where we participate in advances to mortgage brokers ("advances"). The mortgage brokers originate residential mortgage loans with the intent to sell them on the secondary market. We participate in the advance to the mortgage broker, which is secured by the underlying mortgage loan, until it is ultimately sold on the secondary market. As such, the average life of each participated advance is approximately 20-30 days. Funds from the sale of the loan are used to payoff our participation in the advance to the mortgage broker. We classify these advances as commercial loans and include the outstanding balance in commercial loans on our balance sheet. Under the participation agreement, we committed to a maximum outstanding aggregate amount of $30,000. The difference between our outstanding balances and the maximum outstanding aggregate amount is classified as “Unfunded commitments under lines of credit” in the “Contractual Obligations and Loan Commitments” section of the Management's Discussion and Analysis of Financial Condition and Results of Operations of this report.
We offer adjustable rate mortgages, construction loans, and fixed rate residential real estate loans which have amortization periods up to a maximum of 30 years. We consider the anticipated direction of interest rates, balance sheet duration, the sensitivity of our balance sheet to changes in interest rates, and overall loan demand to determine whether or not to sell fixed rate loans to Freddie Mac.

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Table of Contents

Our lending policies generally limit the maximum loan-to-value ratio on residential real estate loans to 100% of the lower of the appraised value of the property or the purchase price. Private mortgage insurance is typically required on loans with loan-to-value ratios in excess of 80% unless the loan qualifies for government guarantees.
Underwriting criteria for originated residential real estate loans generally include:
Evaluation of the borrower’s ability to make monthly payments.
Evaluation of the value of the property securing the loan.
Ensuring the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower’s gross income.
Ensuring all debt servicing does not exceed 40% of income.
Verification of acceptable credit reports.
Verification of employment, income, and financial information.
Appraisals are performed by independent appraisers and reviewed for appropriateness. All originated mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market underwriting system; loans in excess of $500 require the approval of our Internal Loan Committee, the Executive Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors.
Consumer loans include secured and unsecured personal loans. Loans are amortized for a period of up to 12 years based on the age and value of the underlying collateral. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market.
The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL.
The appropriateness of the ALLL is evaluated on a quarterly basis and is based upon a periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. Specific allocations for impaired loans are primarily determined based on the difference between the loan’s outstanding balance and the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell. Historical loss allocations are calculated at the loan class and segment levels based on a migration analysis of the loan portfolio, with the exception of advances to mortgage brokers, over the preceding five years. With no historical losses on advances to mortgage brokers, there is no allocation in the commercial segment displayed in the following tables based on historical loss factors. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A summary of changes in the ALLL and the recorded investment in loans by segments follows:
 
Allowance for Loan Losses
 
Three Months Ended September 30, 2017
 
Commercial

Agricultural

Residential Real Estate

Consumer

Unallocated

Total
July 1, 2017
$
1,978

 
$
475

 
$
2,598

 
$
583

 
$
1,966

 
$
7,600

Charge-offs
(8
)
 

 
(77
)
 
(72
)
 

 
(157
)
Recoveries
134

 

 
41

 
33

 

 
208

Provision for loan losses
65

 
(40
)
 
(71
)
 
89

 
6

 
49

September 30, 2017
$
2,169

 
$
435

 
$
2,491

 
$
633

 
$
1,972

 
$
7,700


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Table of Contents

 
Allowance for Loan Losses

Nine Months Ended September 30, 2017

Commercial

Agricultural

Residential Real Estate

Consumer

Unallocated

Total
January 1, 2017
$
1,814


$
884


$
2,664


$
624


$
1,414


$
7,400

Charge-offs
(60
)



(120
)

(190
)



(370
)
Recoveries
322




140


123




585

Provision for loan losses
93


(449
)

(193
)

76


558


85

September 30, 2017
$
2,169


$
435


$
2,491


$
633


$
1,972


$
7,700

 
Allowance for Loan Losses and Recorded Investment in Loans
 
September 30, 2017

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
933

 
$

 
$
1,618

 
$

 
$

 
$
2,551

Collectively evaluated for impairment
1,236

 
435

 
873

 
633

 
1,972

 
5,149

Total
$
2,169

 
$
435

 
$
2,491

 
$
633

 
$
1,972

 
$
7,700

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
8,525

 
$
10,976

 
$
8,426

 
$
18

 
 
 
$
27,945

Collectively evaluated for impairment
611,610

 
122,022

 
263,054

 
52,913

 
 
 
1,049,599

Total
$
620,135

 
$
132,998

 
$
271,480

 
$
52,931

 
 
 
$
1,077,544

 
Allowance for Loan Losses
 
Three Months Ended September 30, 2016
 
Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
July 1, 2016
$
2,119

 
$
534

 
$
3,130

 
$
541

 
$
1,276

 
$
7,600

Charge-offs

 

 
(57
)
 
(74
)
 

 
(131
)
Recoveries
118

 

 
153

 
43

 

 
314

Provision for loan losses
(367
)
 
612

 
(452
)
 
94

 
130

 
17

September 30, 2016
$
1,870

 
$
1,146

 
$
2,774

 
$
604

 
$
1,406

 
$
7,800

 
Allowance for Loan Losses
 
Nine Months Ended September 30, 2016

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
January 1, 2016
$
2,171

 
$
329

 
$
3,330

 
$
522

 
$
1,048

 
$
7,400

Charge-offs
(48
)
 

 
(426
)
 
(206
)
 

 
(680
)
Recoveries
396

 
92

 
248

 
159

 

 
895

Provision for loan losses
(649
)
 
725

 
(378
)
 
129

 
358

 
185

September 30, 2016
$
1,870

 
$
1,146

 
$
2,774

 
$
604

 
$
1,406

 
$
7,800


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Table of Contents

 
Allowance for Loan Losses and Recorded Investment in Loans
 
December 31, 2016

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
741

 
$
1

 
$
1,629

 
$

 
$

 
$
2,371

Collectively evaluated for impairment
1,073

 
883

 
1,035

 
624

 
1,414

 
5,029

Total
$
1,814

 
$
884

 
$
2,664

 
$
624

 
$
1,414

 
$
7,400

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
7,859

 
$
5,545

 
$
8,638

 
$
26

 
 
 
$
22,068

Collectively evaluated for impairment
567,805

 
120,947

 
257,412

 
42,383

 
 
 
988,547

Total
$
575,664


$
126,492

 
$
266,050

 
$
42,409

 
 
 
$
1,010,615

The following table displays the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit risk ratings as of:
 
September 30, 2017
 
Commercial
 
Agricultural
 
 

Real Estate
 
Other
 
Advances to Mortgage Brokers
 
Total
 
Real Estate
 
Other
 
Total
 
Total
Rating
 
 
 
 
 
 
 
 
 
 
 
 

 
 
1 - Excellent
$
25

 
$
227

 
$

 
$
252

 
$

 
$

 
$

 
$
252

2 - High quality
6,736

 
10,474

 

 
17,210

 
3,088

 
1,001

 
4,089

 
21,299

3 - High satisfactory
117,596

 
41,844

 
22,834

 
182,274

 
21,743

 
9,822

 
31,565

 
213,839

4 - Low satisfactory
327,648

 
77,519

 

 
405,167

 
48,902

 
21,363

 
70,265

 
475,432

5 - Special mention
4,402

 
1,912

 

 
6,314

 
11,206

 
9,115

 
20,321

 
26,635

6 - Substandard
6,303

 
2,402

 

 
8,705

 
3,861

 
1,912

 
5,773

 
14,478

7 - Vulnerable
210

 
3

 

 
213

 
488

 
497

 
985

 
1,198

8 - Doubtful

 

 

 

 

 

 

 

Total
$
462,920

 
$
134,381

 
$
22,834

 
$
620,135

 
$
89,288

 
$
43,710

 
$
132,998

 
$
753,133

 
December 31, 2016
 
Commercial
 
Agricultural
 
 

Real Estate
 
Other
 
Advances to Mortgage Brokers
 
Total
 
Real Estate
 
Other
 
Total
 
Total
Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1 - Excellent
$
28

 
$
438

 
$

 
$
466

 
$

 
$

 
$

 
$
466

2 - High quality
11,821

 
12,091

 
19,688

 
43,600

 
3,566

 
1,426

 
4,992

 
48,592

3 - High satisfactory
103,529

 
41,982

 

 
145,511

 
21,657

 
11,388

 
33,045

 
178,556

4 - Low satisfactory
299,317

 
74,432

 

 
373,749

 
48,955

 
22,715

 
71,670

 
445,419

5 - Special mention
3,781

 
1,178

 

 
4,959

 
6,009

 
3,085

 
9,094

 
14,053

6 - Substandard
5,901

 
1,474

 

 
7,375

 
3,650

 
3,508

 
7,158

 
14,533

7 - Vulnerable
4

 

 

 
4

 

 
533

 
533

 
537

8 - Doubtful

 

 

 

 

 

 

 

Total
$
424,381

 
$
131,595

 
$
19,688

 
$
575,664

 
$
83,837

 
$
42,655

 
$
126,492

 
$
702,156


18

Table of Contents

Internally assigned credit risk ratings are reviewed, at a minimum, when loans are renewed or when management has knowledge of improvements or deterioration of the credit quality of individual credits. Descriptions of the internally assigned credit risk ratings for commercial and agricultural loans are as follows:
1. EXCELLENT – Substantially Risk Free
Credit has strong financial condition and solid earnings history, characterized by:
High liquidity, strong cash flow, low leverage.
Unquestioned ability to meet all obligations when due.
Experienced management, with management succession in place.
Secured by cash.
2. HIGH QUALITY – Limited Risk
Credit with sound financial condition and a positive trend in earnings supplemented by:
Favorable liquidity and leverage ratios.
Ability to meet all obligations when due.
Management with successful track record.
Steady and satisfactory earnings history.
If loan is secured, collateral is of high quality and readily marketable.
Access to alternative financing.
Well defined primary and secondary source of repayment.
If supported by guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident.
3. HIGH SATISFACTORY – Reasonable Risk
Credit with satisfactory financial condition and further characterized by:
Working capital adequate to support operations.
Cash flow sufficient to pay debts as scheduled.
Management experience and depth appear favorable.
Loan performing according to terms.
If loan is secured, collateral is acceptable and loan is fully protected.
4. LOW SATISFACTORY – Acceptable Risk
Credit with bankable risks, although some signs of weaknesses are shown:
Would include most start-up businesses.
Occasional instances of trade slowness or repayment delinquency – may have been 10-30 days slow within the past year.
Management’s abilities are apparent, yet unproven.
Weakness in primary source of repayment with adequate secondary source of repayment.
Loan structure generally in accordance with policy.
If secured, loan collateral coverage is marginal.
Adequate cash flow to service debt, but coverage is low.
To be classified as less than satisfactory, only one of the following criteria must be met.
5. SPECIAL MENTION – Criticized
Credit constitutes an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific loan:
Downward trend in sales, profit levels, and margins.
Impaired working capital position.
Cash flow is strained in order to meet debt repayment.
Loan delinquency (30-60 days) and overdrafts may occur.
Shrinking equity cushion.
Diminishing primary source of repayment and questionable secondary source.

19

Table of Contents

Management abilities are questionable.
Weak industry conditions.
Litigation pending against the borrower.
Collateral or guaranty offers limited protection.
Negative debt service coverage, however the credit is well collateralized and payments are current.
6. SUBSTANDARD – Classified
Credit where the borrower’s current net worth, paying capacity, and value of the collateral pledged is inadequate. There is a distinct possibility that we will implement collection procedures if the loan deficiencies are not corrected. In addition, the following characteristics may apply:
Sustained losses have severely eroded the equity and cash flow.
Deteriorating liquidity.
Serious management problems or internal fraud.
Original repayment terms liberalized.
Likelihood of bankruptcy.
Inability to access other funding sources.
Reliance on secondary source of repayment.
Litigation filed against borrower.
Collateral provides little or no value.
Requires excessive attention of the loan officer.
Borrower is uncooperative with loan officer.
7. VULNERABLE – Classified
Credit is considered “Substandard” and warrants placing on nonaccrual status. Risk of loss is being evaluated and exit strategy options are under review. Other characteristics that may apply:
Insufficient cash flow to service debt.
Minimal or no payments being received.
Limited options available to avoid the collection process.
Transition status, expect action will take place to collect loan without immediate progress being made.
8. DOUBTFUL – Workout
Credit has all the weaknesses inherent in a “Substandard” loan with the added characteristic that collection and/or liquidation is pending. The possibility of a loss is extremely high, but its classification as a loss is deferred until liquidation procedures are completed, or reasonably estimable. Other characteristics that may apply:
Normal operations are severely diminished or have ceased.
Seriously impaired cash flow.
Original repayment terms materially altered.
Secondary source of repayment is inadequate.
Survivability as a “going concern” is impossible.
Collection process has begun.
Bankruptcy petition has been filed.
Judgments have been filed.
Portion of the loan balance has been charged-off.

20

Table of Contents

Our primary credit quality indicator for residential real estate and consumer loans is the individual loan’s past due aging. The following tables summarize the past due and current loans as of:
 
September 30, 2017
 
Accruing Interest
and Past Due:
 
 
 
Total Past Due and Nonaccrual
 
 
 
 

30-59
Days
 
60-89
Days
 
90 Days
or More
 
Nonaccrual
 
 
Current
 
Total
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
466

 
$

 
$

 
$
211

 
$
677

 
$
462,243

 
$
462,920

Commercial other
823

 
29

 

 
3

 
855

 
133,526

 
134,381

Advances to mortgage brokers

 

 

 

 

 
22,834

 
22,834

Total commercial
1,289

 
29

 

 
214

 
1,532

 
618,603

 
620,135

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate

 

 
590

 
488

 
1,078

 
88,210

 
89,288

Agricultural other
490

 
3

 

 
497

 
990

 
42,720

 
43,710

Total agricultural
490

 
3

 
590

 
985

 
2,068

 
130,930

 
132,998

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
1,514

 

 
56

 
383

 
1,953

 
225,215

 
227,168

Junior liens
8

 

 

 
23

 
31

 
7,348

 
7,379

Home equity lines of credit
217

 

 

 

 
217

 
36,716

 
36,933

Total residential real estate
1,739

 

 
56

 
406

 
2,201

 
269,279

 
271,480

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
39

 
11

 

 

 
50

 
49,027

 
49,077

Unsecured
2

 

 

 

 
2

 
3,852

 
3,854

Total consumer
41

 
11

 

 

 
52

 
52,879

 
52,931

Total
$
3,559

 
$
43

 
$
646

 
$
1,605

 
$
5,853

 
$
1,071,691

 
$
1,077,544


21

Table of Contents

 
December 31, 2016
 
Accruing Interest
and Past Due:
 
 
 
Total Past Due and Nonaccrual
 
 
 
 

30-59
Days
 
60-89
Days
 
90 Days
or More
 
Nonaccrual
 
 
Current
 
Total
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
1,580

 
$

 
$
35

 
$
4

 
$
1,619

 
$
422,762

 
$
424,381

Commercial other
1,693

 
35

 

 

 
1,728

 
129,867

 
131,595

Advances to mortgage brokers

 

 

 

 

 
19,688

 
19,688

Total commercial
3,273

 
35

 
35

 
4

 
3,347

 
572,317

 
575,664

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate
191

 

 
508

 

 
699

 
83,138

 
83,837

Agricultural other
19

 

 

 
533

 
552

 
42,103

 
42,655

Total agricultural
210

 

 
508

 
533

 
1,251

 
125,241

 
126,492

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
1,638

 
174

 
22

 
498

 
2,332

 
216,681

 
219,013

Junior liens
15

 

 

 
25

 
40

 
8,317

 
8,357

Home equity lines of credit
270

 
6

 
68

 

 
344

 
38,336

 
38,680

Total residential real estate
1,923

 
180

 
90

 
523

 
2,716

 
263,334

 
266,050

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
110

 

 

 

 
110

 
38,582

 
38,692

Unsecured
5

 

 

 

 
5

 
3,712

 
3,717

Total consumer
115

 

 

 

 
115

 
42,294

 
42,409

Total
$
5,521

 
$
215

 
$
633

 
$
1,060

 
$
7,429

 
$
1,003,186

 
$
1,010,615

Impaired Loans
Loans may be classified as impaired if they meet one or more of the following criteria:
1.
There has been a charge-off of its principal balance (in whole or in part);
2.
The loan has been classified as a TDR; or
3.
The loan is in nonaccrual status.
Impairment is measured on a loan-by-loan basis for commercial and agricultural loans by comparing the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Impairment is measured on a loan-by-loan basis for residential real estate and consumer loans by comparing the loan’s unpaid principal balance to the present value of expected future cash flows discounted at the loan’s effective interest rate.

22

Table of Contents

We do not recognize interest income on impaired loans in nonaccrual status. For impaired loans not classified as nonaccrual, interest income is recognized daily, as earned, according to the terms of the loan agreement and the principal amount outstanding. The following is a summary of information pertaining to impaired loans as of:
 
September 30, 2017
 
December 31, 2016

Recorded Balance
 
Unpaid Principal Balance
 
Valuation Allowance
 
Recorded Balance
 
Unpaid Principal Balance
 
Valuation Allowance
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
4,209

 
$
4,328

 
$
766

 
$
5,811

 
$
5,992

 
$
716

Commercial other
2,239

 
2,239

 
167

 
1,358

 
1,358

 
25

Agricultural real estate

 

 

 

 

 

Agricultural other

 

 

 
134

 
134

 
1

Residential real estate senior liens
8,273

 
8,903

 
1,605

 
8,464

 
9,049

 
1,615

Residential real estate junior liens
70

 
70

 
13

 
72

 
82

 
14

Home equity lines of credit

 

 

 

 

 

Consumer secured

 

 

 

 

 

Total impaired loans with a valuation allowance
14,791

 
15,540

 
2,551

 
15,839

 
16,615

 
2,371

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
1,988

 
2,062

 
 
 
604

 
617

 
 
Commercial other
89

 
89

 
 
 
86

 
97

 
 
Agricultural real estate
7,834

 
7,834

 
 
 
4,037

 
4,037

 
 
Agricultural other
3,142

 
3,142

 
 
 
1,374

 
1,374

 
 
Home equity lines of credit
83

 
383

 
 
 
102

 
402

 
 
Consumer secured
18

 
18

 
 
 
26

 
26

 
 
Total impaired loans without a valuation allowance
13,154

 
13,528

 
 
 
6,229

 
6,553

 
 
Impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial
8,525

 
8,718

 
933

 
7,859

 
8,064

 
741

Agricultural
10,976

 
10,976

 

 
5,545

 
5,545

 
1

Residential real estate
8,426

 
9,356

 
1,618

 
8,638

 
9,533

 
1,629

Consumer
18

 
18

 

 
26

 
26

 

Total impaired loans
$
27,945

 
$
29,068

 
$
2,551

 
$
22,068

 
$
23,168

 
$
2,371












23

Table of Contents

The following is a summary of information pertaining to impaired loans for the:
 
Three Months Ended September 30
 
2017
 
2016

Average Recorded Balance
 
Interest Income Recognized
 
Average Recorded Balance
 
Interest Income Recognized
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
$
4,636

 
$
68

 
$
5,699

 
$
90

Commercial other
1,669

 
28

 
746

 
2

Agricultural real estate

 

 
181

 
4

Agricultural other

 

 
67

 
1

Residential real estate senior liens
8,333

 
79

 
8,896

 
85

Residential real estate junior liens
73

 
1

 
105

 

Home equity lines of credit
35

 

 

 

Consumer secured

 

 

 

Total impaired loans with a valuation allowance
14,746

 
176

 
15,694

 
182

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
1,546

 
31

 
705

 
10

Commercial other
93

 
2

 
67

 
2

Agricultural real estate
7,830

 
98

 
3,360

 
42

Agricultural other
3,221

 
39

 
767

 
11

Home equity lines of credit
86

 
5

 
112

 
4

Consumer secured
19

 

 
31

 
1

Total impaired loans without a valuation allowance
12,795

 
175

 
5,042

 
70

Impaired loans
 
 
 
 
 
 
 
Commercial
7,944

 
129

 
7,217

 
104

Agricultural
11,051

 
137

 
4,375

 
58

Residential real estate
8,527

 
85

 
9,113

 
89

Consumer
19

 

 
31

 
1

Total impaired loans
$
27,541

 
$
351

 
$
20,736

 
$
252


24

Table of Contents

 
Nine Months Ended September 30
 
2017
 
2016

Average Recorded Balance
 
Interest Income Recognized
 
Average Recorded Balance
 
Interest Income Recognized
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
$
4,765

 
$
225

 
$
5,748

 
$
259

Commercial other
1,363

 
75

 
298

 
5

Agricultural real estate

 

 
91

 
6

Agricultural other
22

 

 
78

 
1

Residential real estate senior liens
8,379

 
245

 
9,439

 
278

Residential real estate junior liens
75

 
2

 
126

 
2

Home equity lines of credit
23

 

 

 

Consumer secured

 

 

 

Total impaired loans with a valuation allowance
14,627

 
547


15,780


551

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
1,483

 
83

 
995

 
57

Commercial other
109

 
6

 
92

 
6

Agricultural real estate
5,936

 
218

 
3,454

 
130

Agricultural other
2,353

 
85

 
574

 
27

Home equity lines of credit
115

 
15

 
118

 
12

Consumer secured
22

 

 
33

 
3

Total impaired loans without a valuation allowance
10,018

 
407

 
5,266

 
235

Impaired loans
 
 
 
 
 
 
 
Commercial
7,720

 
389

 
7,133

 
327

Agricultural
8,311

 
303

 
4,197

 
164

Residential real estate
8,592

 
262

 
9,683

 
292

Consumer
22

 

 
33

 
3

Total impaired loans
$
24,645

 
$
954

 
$
21,046

 
$
786

We had committed to advance $125 and $117 in connection with impaired loans, which includes TDRs, as of September 30, 2017 and December 31, 2016, respectively.
Troubled Debt Restructurings
Loan modifications are considered to be TDRs when the modification includes terms outside of normal lending practices to a borrower who is experiencing financial difficulties.
Typical concessions granted include, but are not limited to:
Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics.
Extending the amortization period beyond typical lending guidelines for loans with similar risk characteristics.
Agreeing to an interest only payment structure and delaying principal payments.
Forgiving principal.
Forgiving accrued interest.
To determine if a borrower is experiencing financial difficulties, factors we consider include:
The borrower is currently in default on any of their debt.
The borrower would likely default on any of their debt if the concession was not granted.
The borrower’s cash flow was insufficient to service all of their debt if the concession was not granted.
The borrower has declared, or is in the process of declaring, bankruptcy.
The borrower is unlikely to continue as a going concern (if the entity is a business).

25

Table of Contents

The following is a summary of information pertaining to TDRs granted for the:
 
Three Months Ended September 30
 
2017
 
2016

Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
Commercial other
3

 
$
1,385

 
$
1,385

 
1

 
$
1,315

 
$
1,315

Agricultural other

 

 

 
2

 
319

 
319

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Senior liens
2

 
179

 
179

 

 

 

Junior liens

 

 

 

 

 

Total residential real estate
2

 
179

 
179

 

 

 

Consumer unsecured

 

 

 

 

 

Total
5


$
1,564


$
1,564

 
3


$
1,634


$
1,634

 
Nine Months Ended September 30
 
2017
 
2016

Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
Commercial other
6

 
$
1,698

 
$
1,698

 
1

 
$
1,315

 
$
1,315

Agricultural other
7

 
5,445

 
5,445

 
5

 
520

 
520

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Senior liens
5

 
434

 
434

 
2

 
26

 
26

Junior liens
1

 
8

 
8

 

 

 

Total residential real estate
6

 
442

 
442

 
2

 
26

 
26

Consumer unsecured

 

 

 
1

 
2

 
2

Total
19

 
$
7,585

 
$
7,585

 
9

 
$
1,863

 
$
1,863

The following tables summarize concessions we granted to borrowers in financial difficulty for the:
 
Three Months Ended September 30
 
2017
 
2016

Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
Commercial other

 
$

 
3

 
$
1,385

 

 
$

 
1

 
$
1,315

Agricultural other

 

 

 

 
1

 
14

 
1

 
305

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens

 

 
2

 
179

 

 

 

 

Junior liens

 

 

 

 

 

 

 

Total residential real estate

 

 
2

 
179

 

 

 

 

Consumer unsecured

 

 

 

 

 

 

 

Total


$


5


$
1,564

 
1


$
14


2


$
1,620


26

Table of Contents


Nine Months Ended September 30

2017
 
2016

Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
Commercial other

 
$

 
6

 
$
1,698

 

 
$

 
1

 
$
1,315

Agricultural other
4

 
1,349

 
3

 
4,096

 
1

 
14

 
4

 
506

Residential real estate


 


 


 


 


 


 


 


Senior liens

 

 
5

 
434

 
2

 
26

 

 

Junior liens
1

 
8

 

 

 

 

 

 

Total residential real estate
1

 
8

 
5

 
434

 
2

 
26

 

 

Consumer unsecured

 

 

 

 

 

 
1

 
2

Total
5

 
$
1,357

 
14

 
$
6,228

 
3

 
$
40

 
6

 
$
1,823

We did not restructure any loans by forgiving principal or accrued interest in the three and nine month periods ended September 30, 2017 or 2016.
Based on our historical loss experience, losses associated with TDRs are not significantly different than other impaired loans within the same loan segment. As such, TDRs, including TDRs that have been modified in the past 12 months that subsequently defaulted, are analyzed in the same manner as other impaired loans within their respective loan segment.
We had no loans that defaulted in the three and nine month periods ended September 30, 2017 and September 30, 2016 which were modified within 12 months prior to the default date.
The following is a summary of TDR loan balances as of:
 
September 30, 2017
 
December 31, 2016
TDRs
$
27,259

 
$
21,382

Note 6 – Equity Securities Without Readily Determinable Fair Values
Included in equity securities without readily determinable fair values are restricted securities, which are carried at cost, and investments in unconsolidated entities accounted for under the equity method of accounting.
Equity securities without readily determinable fair values consist of the following as of:

September 30
2017
 
December 31
2016
FHLB Stock
$
13,700

 
$
11,900

Corporate Settlement Solutions, LLC
7,428

 
7,461

FRB Stock
1,999

 
1,999

Other
334

 
334

Total
$
23,461

 
$
21,694


27

Table of Contents

Note 7 – Foreclosed Assets
Foreclosed assets are included in other assets in the consolidated balance sheets and consist of other real estate owned and repossessed assets. The following is a summary of foreclosed assets as of:

September 30
2017
 
December 31
2016
Consumer mortgage loans collateralized by residential real estate foreclosed as a result of obtaining physical possession
$
20

 
$
18

All other foreclosed assets
220

 
213

Total
$
240

 
$
231

There were $260 and $18 of consumer mortgage loans collateralized by residential real estate in the process of foreclosure as of September 30, 2017 and December 31, 2016.
Below is a summary of changes in foreclosed assets during the:
 
Three Months Ended September 30
 
2017
 
2016
Balance, July 1
$
229

 
$
249

Properties transferred
118

 
95

Impairments
(2
)
 

Proceeds from sale
(105
)
 
(60
)
Balance, September 30
$
240


$
284

 
Nine Months Ended September 30

2017
 
2016
Balance, January 1
$
231

 
$
421

Properties transferred
214

 
211

Impairments
(2
)
 

Proceeds from sale
(203
)
 
(348
)
Balance, September 30
$
240

 
$
284

Note 8 – Borrowed Funds
Borrowed funds consist of the following obligations as of:
 
September 30, 2017
 
December 31, 2016

Amount
 
Rate
 
Amount
 
Rate
FHLB advances
$
310,000

 
1.83
%
 
$
270,000

 
1.82
%
Securities sold under agreements to repurchase without stated maturity dates
54,977

 
0.12
%
 
60,894

 
0.13
%
Federal funds purchased
2,050

 
1.39
%
 
6,800

 
1.00
%
Total
$
367,027

 
1.57
%
 
$
337,694

 
1.50
%
FHLB advances are collateralized by a blanket lien on all qualified 1-4 family residential real estate loans, specific AFS securities, and FHLB stock.

28

Table of Contents

The following table lists the maturities and weighted average interest rates of FHLB advances as of:
 
September 30, 2017
 
December 31, 2016

Amount
 
Rate
 
Amount
 
Rate
Fixed rate due 2017
$
40,000

 
1.13
%
 
$
70,000

 
1.39
%
Fixed rate due 2018
50,000

 
2.16
%
 
50,000

 
2.16
%
Fixed rate due 2019
85,000

 
1.87
%
 
60,000

 
1.99
%
Fixed rate due 2020
35,000

 
1.52
%
 
10,000

 
1.98
%
Fixed rate due 2021
50,000

 
1.91
%
 
50,000

 
1.91
%
Variable rate due 2021 1
10,000

 
1.61
%
 
10,000

 
1.21
%
Fixed rate due 2022
20,000

 
1.97
%
 

 
%
Fixed rate due 2023
10,000

 
3.90
%
 
10,000

 
3.90
%
Fixed rate due 2026
10,000

 
1.17
%
 
10,000

 
1.17
%
Total
$
310,000

 
1.83
%
 
$
270,000

 
1.82
%
(1) 
Hedged advance (see "Derivative Instruments" section below)
Securities sold under agreements to repurchase are classified as secured borrowings and are reflected at the amount of cash received in connection with the transaction. The securities underlying the agreements have a carrying value and a fair value of $54,996 and $60,918 at September 30, 2017 and December 31, 2016, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.
Securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances generally mature within one to four days from the transaction date. The following table provides a summary of securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances.
 
Three Months Ended September 30
 
2017
 
2016
 
Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
 
Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates
$
58,464

 
$
53,846

 
0.13
%
 
$
56,057

 
$
54,446

 
0.13
%
Federal funds purchased
3,815

 
1,474

 
1.20
%
 
20,600

 
8,848

 
0.69
%
FRB Discount Window

 
82

 
1.60
%
 

 

 
%
 
Nine Months Ended September 30
 
2017
 
2016

Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
 
Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates
$
58,464

 
$
55,051

 
0.13
%
 
$
61,783

 
$
57,159

 
0.13
%
Federal funds purchased
5,965

 
3,280

 
1.13
%
 
20,600

 
8,614

 
0.69
%
FRB Discount Window

 
57

 
1.54
%
 

 

 
%
We had pledged AFS securities and 1-4 family residential real estate loans in the following amounts at:

September 30
2017
 
December 31
2016
Pledged to secure borrowed funds
$
416,279

 
$
363,427

Pledged to secure repurchase agreements
54,996

 
60,918

Pledged for public deposits and for other purposes necessary or required by law
29,774

 
33,916

Total
$
501,049

 
$
458,261


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Table of Contents

AFS securities pledged to repurchase agreements without stated maturity dates consisted of the following at:

September 30
2017
 
December 31
2016
States and political subdivisions
$
4,256

 
$
5,676

Mortgage-backed securities
15,419

 
11,383

Collateralized mortgage obligations
35,321

 
43,859

Total
$
54,996

 
$
60,918

AFS securities pledged to repurchase agreements are monitored to ensure the appropriate level is collateralized. In the event of maturities, calls, significant principal repayments, or significant decline in market values, we have adequate levels of AFS securities to pledge to satisfy required collateral.
As of September 30, 2017, we had the ability to borrow up to an additional $114,839, based on assets pledged as collateral. We had no investment securities that are restricted to be pledged for specific purposes.
Derivative Instruments
We enter into interest rate swaps to manage exposure to interest rate risk and variability in cash flows. The interest rate swaps, associated with our variable rate borrowings, are designated upon inception as cash flow hedges of forecasted interest payments. We enter into LIBOR-based interest rate swaps that involve the receipt of variable amounts in exchange for fixed rate payments, in effect converting variable rate debt to fixed rate debt.
Cash flow hedges are assessed for effectiveness using regression analysis. The effective portion of changes in fair value are recorded in OCI and subsequently reclassified into interest expense in the same period in which the related interest on the variable rate borrowings affects earnings. In the event that a portion of the changes in fair value were determined to be ineffective, the ineffective amount would be recorded in earnings.
The following tables provide information on derivatives related to variable rate borrowings as of:
 
September 30, 2017
 
Pay Rate
 
Receive Rate
 
Remaining Life (Years)
 
Notional Amount
 
Balance Sheet Location
 
Fair Value
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Cash Flow Hedges:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
1.56
%
 
3-Month LIBOR
 
3.6
 
$
10,000

 
Other Assets
 
$
215

 
December 31, 2016
 
Pay Rate
 
Receive Rate
 
Remaining Life (Years)
 
Notional Amount
 
Balance Sheet Location
 
Fair Value
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Cash Flow Hedges:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
1.56
%
 
3-Month LIBOR
 
4.3
 
$
10,000

 
Other Assets
 
$
248

Derivatives contain an element of credit risk which arises from the possibility that we will incur a loss as a result of a counterparty failing to meet its contractual obligations. Credit risk is minimized through counterparty collateral, transaction limits and monitoring procedures. We also manage dealer credit risk by entering into interest rate derivatives only with primary and highly rated counterparties, the use of ISDA master agreements and counterparties limits. We do not anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.

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Table of Contents

Note 9 – Other Noninterest Expenses
A summary of expenses included in other noninterest expenses is as follows for the:

Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30
 
2017
 
2016
 
2017
 
2016
ATM and debit card fees
$
253

 
$
210

 
$
873

 
$
627

Audit and related fees
322

 
319

 
757

 
664

Consulting fees
259

 
198

 
672

 
567

Director fees
212

 
207

 
634

 
630

Loan underwriting fees
237

 
142

 
546

 
377

Donations and community relations
190

 
134

 
488

 
399

FDIC insurance premiums
172

 
224

 
480

 
646

Marketing costs
172

 
101

 
361

 
359

Education and travel
143

 
73

 
332

 
309

Printing and supplies
110

 
105

 
320

 
325

Postage and freight
85

 
96

 
304

 
293

All other
438

 
486

 
1,427

 
1,692

Total other
$
2,593

 
$
2,295

 
$
7,194

 
$
6,888

Note 10 – Federal Income Taxes
The reconciliation of the provision for federal income taxes and the amount computed at the federal statutory tax rate of 34% of income before federal income tax expense is as follows for the:

Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30
 
2017
 
2016
 
2017
 
2016
Income taxes at 34% statutory rate
$
1,458

 
$
1,481

 
$
4,317

 
$
4,036

Effect of nontaxable income
 
 
 
 
 
 
 
Interest income on tax exempt municipal securities
(452
)
 
(457
)
 
(1,361
)
 
(1,400
)
Earnings on corporate owned life insurance policies
(60
)
 
(62
)
 
(183
)
 
(192
)
Effect of tax credits
(186
)
 
(188
)
 
(566
)
 
(575
)
Other
(18
)
 
(19
)
 
(54
)
 
(55
)
Total effect of nontaxable income
(716
)
 
(726
)
 
(2,164
)
 
(2,222
)
Effect of nondeductible expenses
8

 
8

 
27

 
41

Federal income tax expense
$
750

 
$
763

 
$
2,180

 
$
1,855


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Table of Contents

Note 11 – Fair Value
Following is a description of the valuation methodologies, key inputs, and an indication of the level of the fair value hierarchy in which the assets or liabilities are classified.
Cash and cash equivalents: The carrying amounts of cash and demand deposits due from banks and interest bearing balances due from banks approximate fair values. As such, we classify cash and cash equivalents as Level 1.
AFS securities: AFS securities are recorded at fair value on a recurring basis. Level 1 fair value measurement is based upon quoted prices for identical instruments. Level 2 fair value measurement is based upon quoted prices for similar instruments. If quoted prices are not available, fair values are measured using independent pricing models or other model based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions. The values for Level 1 and Level 2 investment securities are generally obtained from an independent third party. On a quarterly basis, we compare the values provided to alternative pricing sources.
Mortgage loans AFS: Mortgage loans AFS are carried at the lower of cost or fair value. The fair value of mortgage loans AFS are based on the price secondary markets are currently offering for portfolios with similar characteristics. As such, we classify mortgage loans AFS subject to nonrecurring fair value adjustments as Level 2.
Loans: For variable rate loans with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. As such, we classify loans as Level 3 assets.
We do not record loans at fair value on a recurring basis. However, from time-to-time, loans are classified as impaired and a specific allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will be significantly different than the contractual terms of the original loan agreement are considered impaired. Once a loan is identified as impaired, we measure the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less costs to sell, if the loan is collateral dependent. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.
We review the net realizable values of the underlying collateral for collateral dependent impaired loans on at least a quarterly basis for all loan types. To determine the collateral value, we utilize independent appraisals, broker price opinions, or internal evaluations. We review these valuations to determine whether an additional discount should be applied given the age of market information that may have been considered as well as other factors such as costs to sell an asset if it is determined that the collateral will be liquidated in connection with the ultimate settlement of the loan. We use these valuations to determine if any specific reserves or charge-offs are necessary. We may obtain new valuations in certain circumstances, including when there has been significant deterioration in the condition of the collateral, if the foreclosure process has begun, or if the existing valuation is deemed to be outdated.
The following tables list the quantitative fair value information about impaired loans as of:

September 30, 2017
Valuation Technique
Fair Value
Unobservable Input
 
Range
 
 
Discount applied to collateral:
 
 
 
 
Real Estate
 
20% - 30%
 
 
Equipment
 
20% - 45%
 
 
Accounts receivable
 
50%
Discounted value
$16,158
Cash crop inventory
 
30% - 40%
 
 
Other inventory
 
50% - 75%
 
 
Liquor license
 
75%
 
 
Furniture, fixtures & equipment
 
35% - 45%

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Table of Contents


December 31, 2016
Valuation Technique
Fair Value
Unobservable Input
 
Range
 
 
Discount applied to collateral:
 
 
 
 
Real Estate
 
20% - 30%
 
 
Equipment
 
20% - 45%
Discounted value
$9,166
Cash crop inventory
 
30% - 40%
 
 
Liquor license
 
75%
 
 
Furniture, fixtures & equipment
 
45%
Collateral discount rates may have ranges to accommodate differences in the age of the independent appraisal, broker price opinion, or internal evaluation.
Accrued interest receivable: The carrying amounts of accrued interest receivable approximate fair value. As such, we classify accrued interest receivable as Level 1.
Equity securities without readily determinable fair values: Included in equity securities without readily determinable fair values are FHLB stock and FRB stock as well as our minority ownership interest in Corporate Settlement Solutions, LLC. The investment in Corporate Settlement Solutions, LLC, a title insurance agency, was made in the first quarter 2008 and we account for our investment under the equity method of accounting.
The lack of an active market, or other independent sources to validate fair value estimates coupled with the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. As the fair values of these investments are not readily determinable, they are not disclosed under a specific fair value hierarchy; however, they are reviewed quarterly for impairment. If we were to record an impairment adjustment related to these securities, it would be classified as a nonrecurring Level 3 fair value adjustment. During 2017 and 2016, there were no impairments recorded on equity securities without readily determinable fair values.
Foreclosed assets: Upon transfer from the loan portfolio, foreclosed assets (which are included in other assets) are adjusted to and subsequently carried at the lower of carrying value or fair value less costs to sell. Net realizable value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. Due to the inherent level of estimation in the valuation process, we classify foreclosed assets as nonrecurring Level 3.
The table below lists the quantitative fair value information related to foreclosed assets as of:
 
September 30, 2017
Valuation Technique
Fair Value
 
Unobservable Input
 
Range
 
 
 
Discount applied to collateral:
 
 
Discounted value
$
240

 
Real Estate
 
20% - 30%
 
December 31, 2016
Valuation Technique
Fair Value
 
Unobservable Input
 
Range
 
 
 
Discount applied to collateral:
 
 
Discounted value
$
231

 
Real Estate
 
20% - 30%
Collateral discount rates may have ranges to accommodate differences in the age of the independent appraisal, broker price opinion, or internal evaluations.
Goodwill and other intangible assets: Acquisition intangibles and goodwill are evaluated for potential impairment on at least an annual basis. Acquisition intangibles and goodwill are typically qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired. If it is determined that the carrying balance of acquisition intangibles or goodwill is more likely than not to be impaired, we perform a cash flow valuation to determine the extent of the potential impairment. If the testing resulted in impairment, we would classify goodwill and other acquisition intangibles subjected to nonrecurring fair value adjustments as Level 3. During 2017 and 2016, there were no impairments recorded on goodwill and other acquisition intangibles.

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Table of Contents

OMSR: OMSR (which are included in other assets) are subject to impairment testing. To test for impairment, we utilize a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and discount rates. If the valuation model reflects a value less than the carrying value, OMSR are adjusted to fair value through a valuation allowance as determined by the model. As such, we classify OMSR subject to nonrecurring fair value adjustments as Level 2.
Deposits: The fair value of demand, savings, and money market deposits are equal to their carrying amounts and are classified as Level 1. Fair values for variable rate certificates of deposit approximate their carrying value. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. As such, fixed rate certificates of deposit are classified as Level 2.
Borrowed funds: The carrying amounts of federal funds purchased, borrowings under overnight repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values. The fair values of other borrowed funds are estimated using discounted cash flow analyses based on current incremental borrowing arrangements. As such, borrowed funds are classified as Level 2.
Accrued interest payable: The carrying amounts of accrued interest payable approximate fair value. As such, we classify accrued interest payable as Level 1.
Derivative instruments: Derivative instruments, consisting solely of interest rate swaps, are recorded at fair value on a recurring basis. Derivatives qualifying as cash flow hedges, when highly effective, are reported at fair value in other assets or other liabilities on our Consolidated Balance Sheets with changes in value recorded in OCI. Should the hedge no longer be considered effective, the ineffective portion of the change in fair value is recorded directly in earnings in the period in which the change occurs. The fair value of a derivative is determined by quoted market prices and model based valuation techniques. As such, we classify derivative instruments as Level 2.
Commitments to extend credit, standby letters of credit, and undisbursed loans: Our commitments to extend credit, standby letters of credit, and undisbursed funds have no carrying amount and are estimated to have no realizable fair value. Historically, a majority of the unused commitments to extend credit have not been drawn upon and, generally, we do not receive fees in connection with these commitments other than standby letter of credit fees, which are not significant.
The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Although we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement.

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Table of Contents

Estimated Fair Values of Financial Instruments Not Recorded at Fair Value in their Entirety on a Recurring Basis
Disclosure of the estimated fair values of financial instruments, which differ from carrying values, often requires the use of estimates. In cases where quoted market values in an active market are not available, we use present value techniques and other valuation methods to estimate the fair values of our financial instruments. These valuation methods require considerable judgment and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used.
The carrying amount and estimated fair value of financial instruments not recorded at fair value in their entirety on a recurring basis were as follows as of:
 
September 30, 2017

Carrying
Value
 
Estimated
Fair Value
 
Level 1
 
Level 2
 
Level 3
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
21,067

 
$
21,067

 
$
21,067

 
$

 
$

Mortgage loans AFS
1,237

 
1,245

 

 
1,245

 

Gross loans
1,077,544

 
1,056,912

 

 

 
1,056,912

Less allowance for loan and lease losses
7,700

 
7,700

 

 

 
7,700

Net loans
1,069,844

 
1,049,212

 

 

 
1,049,212

Accrued interest receivable
7,388

 
7,388

 
7,388

 

 

Equity securities without readily determinable fair values (1)
23,461

 
N/A

 

 

 

OMSR
2,413

 
2,413

 

 
2,413

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
791,567

 
791,567

 
791,567

 

 

Deposits with stated maturities
424,495

 
423,536

 

 
423,536

 

Borrowed funds
367,027

 
367,873

 

 
367,873

 

Accrued interest payable
633

 
633

 
633

 

 

 
December 31, 2016
 
Carrying
Value
 
Estimated
Fair Value
 
Level 1
 
Level 2
 
Level 3
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
22,894

 
$
22,894

 
$
22,894

 
$

 
$

Mortgage loans AFS
1,816

 
1,836

 

 
1,836

 

Gross loans
1,010,615

 
991,009

 

 

 
991,009

Less allowance for loan and lease losses
7,400

 
7,400

 

 

 
7,400

Net loans
1,003,215

 
983,609

 

 

 
983,609

Accrued interest receivable
6,580

 
6,580

 
6,580

 

 

Equity securities without readily determinable fair values (1)
21,694

 
N/A

 

 

 

OMSR
2,306

 
2,306

 

 
2,306

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
761,626

 
761,626

 
761,626

 

 

Deposits with stated maturities
433,414

 
430,088

 

 
430,088

 

Borrowed funds
337,694

 
336,975

 

 
336,975

 

Accrued interest payable
574

 
574

 
574

 

 

(1) 
Due to the characteristics of equity securities without readily determinable fair values, they are not disclosed under a specific fair value hierarchy. If we were to record an impairment adjustment related to these securities, such amount would be classified as a nonrecurring Level 3 fair value adjustment.

35

Table of Contents

Financial Instruments Recorded at Fair Value
The table below presents the recorded amount of assets and liabilities measured at fair value on:
 
September 30, 2017
 
December 31, 2016

Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
Recurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AFS securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprises
$
232

 
$

 
$
232

 
$

 
$
10,259

 
$

 
$
10,259

 
$

States and political subdivisions
213,457

 

 
213,457

 

 
212,919

 

 
212,919

 

Auction rate money market preferred
3,172

 

 
3,172

 

 
2,794

 

 
2,794

 

Preferred stocks
3,651

 
3,651

 

 

 
3,425

 
3,425

 

 

Mortgage-backed securities
215,914

 

 
215,914

 

 
227,256

 

 
227,256

 

Collateralized mortgage obligations
116,499

 

 
116,499

 

 
101,443

 

 
101,443

 

Total AFS securities
552,925

 
3,651

 
549,274

 

 
558,096

 
3,425

 
554,671

 

Derivative instruments
215

 

 
215

 

 
248

 

 
248

 

Nonrecurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans (net of the ALLL)
16,158

 

 

 
16,158

 
9,166

 

 

 
9,166

Foreclosed assets
240

 

 

 
240

 
231

 

 

 
231

Total
$
569,538

 
$
3,651

 
$
549,489

 
$
16,398

 
$
567,741

 
$
3,425

 
$
554,919

 
$
9,397

Percent of assets and liabilities measured at fair value
 
 
0.64
%
 
96.48
%
 
2.88
%
 
 
 
0.60
%
 
97.74
%
 
1.66
%
We had no assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a recurring basis, as of September 30, 2017. Foreclosed assets, which are recorded at fair value with changes in fair value recognized through earnings on a nonrecurring basis, were written down to $240 as of September 30, 2017 which resulted in an impairment recorded through earnings in the amount of $2 for the nine month period ended September 30, 2017. We had no other assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a nonrecurring basis, as of September 30, 2017.

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Table of Contents

Note 12 – Accumulated Other Comprehensive Income
The following table summarizes the changes in AOCI by component for the:
 
Three Months Ended September 30
 
2017
 
2016

Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
 
Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
Balance, July 1
$
2,923

 
$
135

 
$
(2,972
)
 
$
86

 
$
10,982

 
$
(100
)
 
$
(3,315
)
 
$
7,567

OCI before reclassifications
(96
)
 
11

 

 
(85
)
 
(2,548
)
 
91

 

 
(2,457
)
Amounts reclassified from AOCI

 

 

 

 

 

 

 

Subtotal
(96
)
 
11

 

 
(85
)
 
(2,548
)
 
91

 

 
(2,457
)
Tax effect
54

 
(4
)
 

 
50

 
937

 
(31
)
 

 
906

OCI, net of tax
(42
)
 
7

 

 
(35
)
 
(1,611
)
 
60

 

 
(1,551
)
Balance, September 30
$
2,881


$
142


$
(2,972
)

$
51


$
9,371


$
(40
)

$
(3,315
)

$
6,016

 
Nine Months Ended September 30
 
2017
 
2016

Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
 
Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
Balance, January 1
$
30

 
$
164

 
$
(2,972
)
 
$
(2,778
)
 
$
3,536

 
$

 
$
(3,315
)
 
$
221

OCI before reclassifications
4,151

 
(33
)
 

 
4,118

 
8,793

 
(61
)
 

 
8,732

Amounts reclassified from AOCI
(142
)
 

 

 
(142
)
 
(245
)
 

 

 
(245
)
Subtotal
4,009

 
(33
)
 

 
3,976

 
8,548

 
(61
)
 

 
8,487

Tax effect
(1,158
)
 
11

 

 
(1,147
)
 
(2,713
)
 
21

 

 
(2,692
)
OCI, net of tax
2,851

 
(22
)
 

 
2,829

 
5,835

 
(40
)
 

 
5,795

Balance, September 30
$
2,881

 
$
142

 
$
(2,972
)
 
$
51

 
$
9,371

 
$
(40
)
 
$
(3,315
)
 
$
6,016

Included in OCI for the three and nine month periods ended September 30, 2017 and 2016 are changes in unrealized holding gains and losses related to auction rate money market preferred and preferred stocks. For federal income tax purposes, these securities are considered equity investments. As such, no deferred federal income taxes related to unrealized holding gains or losses are expected or recorded.

37

Table of Contents

A summary of the components of unrealized holding gains on AFS securities included in OCI follows for the:
 
Three Months Ended September 30
 
2017
 
2016

Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
 
Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
Unrealized gains (losses) arising during the period
$
63

 
$
(159
)
 
$
(96
)
 
$
208

 
$
(2,756
)
 
$
(2,548
)
Reclassification adjustment for net realized (gains) losses included in net income

 

 

 

 

 

Net unrealized gains (losses)
63

 
(159
)
 
(96
)
 
208

 
(2,756
)
 
(2,548
)
Tax effect

 
54

 
54

 

 
937

 
937

Unrealized gains (losses), net of tax
$
63


$
(105
)

$
(42
)

$
208


$
(1,819
)

$
(1,611
)
 
Nine Months Ended September 30
 
2017
 
2016

Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
 
Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
Unrealized gains (losses) arising during the period
$
604

 
$
3,547

 
$
4,151

 
$
568

 
$
8,225

 
$
8,793

Reclassification adjustment for net realized (gains) losses included in net income

 
(142
)
 
(142
)
 

 
(245
)
 
(245
)
Net unrealized gains (losses)
604

 
3,405

 
4,009

 
568

 
7,980

 
8,548

Tax effect

 
(1,158
)
 
(1,158
)
 

 
(2,713
)
 
(2,713
)
Unrealized gains (losses), net of tax
$
604

 
$
2,247

 
$
2,851

 
$
568

 
$
5,267

 
$
5,835


38

Table of Contents

Note 13 – Parent Company Only Financial Information
Interim Condensed Balance Sheets

September 30
2017
 
December 31
2016
ASSETS
 
 
 
Cash on deposit at the Bank
$
945

 
$
1,297

AFS securities

 
251

Investments in subsidiaries
146,138

 
138,549

Premises and equipment
1,961

 
1,991

Other assets
52,795

 
52,846

TOTAL ASSETS
$
201,839

 
$
194,934

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Other liabilities
$
5,376

 
$
7,035

Shareholders' equity
196,463

 
187,899

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
201,839

 
$
194,934

Interim Condensed Statements of Income
 
Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30

2017
 
2016
 
2017
 
2016
Income
 
 
 
 
 
 
 
Dividends from subsidiaries
$
2,900

 
$
2,000

 
$
7,200

 
$
5,600

Interest income

 
3

 
2

 
11

Management fee and other
1,660

 
1,680

 
4,901

 
4,962

Total income
4,560

 
3,683

 
12,103

 
10,573

Expenses
 
 
 
 
 
 
 
Compensation and benefits
1,118

 
1,196

 
3,608

 
3,580

Occupancy and equipment
456

 
438

 
1,332

 
1,281

Audit and related fees
148

 
193

 
412

 
389

Other
556

 
427

 
1,731

 
1,561

Total expenses
2,278

 
2,254

 
7,083

 
6,811

Income before income tax benefit and equity in undistributed earnings of subsidiaries
2,282

 
1,429

 
5,020

 
3,762

Federal income tax benefit
209

 
199

 
737

 
616

Income before equity in undistributed earnings of subsidiaries
2,491

 
1,628

 
5,757

 
4,378

Undistributed earnings of subsidiaries
1,045

 
1,965

 
4,759

 
5,639

Net income
$
3,536

 
$
3,593

 
$
10,516

 
$
10,017


39

Table of Contents

Interim Condensed Statements of Cash Flows
 
Nine Months Ended 
 September 30

2017
 
2016
Operating activities
 
 
 
Net income
$
10,516

 
$
10,017

Adjustments to reconcile net income to cash provided by operations
 
 
 
Undistributed earnings of subsidiaries
(4,759
)
 
(5,639
)
Undistributed earnings of equity securities without readily determinable fair values
33

 
(287
)
Share-based payment awards under equity compensation plan
502

 
443

Depreciation
116

 
117

Changes in operating assets and liabilities which provided (used) cash
 
 
 
Other assets
19

 
177

Accrued interest and other liabilities
(1,659
)
 
(2,575
)
Net cash provided by (used in) operating activities
4,768

 
2,253

Investing activities
 
 
 
Maturities, calls, principal payments, and sales of AFS securities
249

 

Purchases of premises and equipment
(86
)
 
(86
)
Net cash provided by (used in) investing activities
163

 
(86
)
Financing activities
 
 
 
Cash dividends paid on common stock
(5,950
)
 
(5,697
)
Proceeds from the issuance of common stock
4,999

 
3,683

Common stock repurchased
(4,005
)
 
(2,749
)
Common stock purchased for deferred compensation obligations
(327
)
 
(279
)
Net cash provided by (used in) financing activities
(5,283
)
 
(5,042
)
Increase (decrease) in cash and cash equivalents
(352
)
 
(2,875
)
Cash and cash equivalents at beginning of period
1,297

 
4,125

Cash and cash equivalents at end of period
$
945

 
$
1,250

Note 14 – Operating Segments
Our reportable segments are based on legal entities that account for at least 10% of net operating results. The operations of the Bank as of September 30, 2017 and 2016 and each of the three and nine month periods then ended, represent approximately 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented.

40

Table of Contents

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
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 unaudited three and nine month periods ended September 30, 2017 and 2016. This analysis should be read in conjunction with our 2016 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 nine months ended September 30, 2017, we reported net income of $3,536 and $10,516 and earnings per common share of $0.45 and $1.34, respectively. Net income and earnings per common share for the same periods of 2016 were $3,593 and $10,017 and $0.46 and $1.28, respectively. The increase in year-to-date earnings was primarily driven by interest income which increased $3,429 for the first nine months of 2017 in comparison to the same period in 2016. Increased interest income resulted primarily from strong loan growth during the past year.
During the nine month period ended September 30, 2017, total assets grew by 3.45% to $1,791,967, and assets under management increased to $2,528,385 which includes loans sold and serviced, and assets managed by our Investment and Trust Services Department of $736,418. Total loans increased by $66,929 from December 31, 2016 which was largely driven by growth of $44,471 in the commercial loan portfolio. The growth in the loan portfolio was funded by an increase of $21,022 in deposits since December 31, 2016, with the remainder being funded through additional borrowed funds.
Our net yield on interest earning assets (FTE) remained low at 3.03% for the nine month period ended September 30, 2017. The growth in net interest income will increase primarily through continued growth in a strategic mix of loans, investments, and other income earning assets. We do not anticipate that the Federal Reserve Bank will increase short term interest rates significantly in the near future; therefore, we anticipate marginal improvements in our net yield on interest earning assets in the short term. We are committed to increasing earnings and shareholder value through growth in our loan portfolio, investment and trust services, and in deposits while managing operating costs.
Reclassifications: Certain amounts reported in the 2016 consolidated financial statements have been reclassified to conform with the 2017 presentation.

41

Table of Contents

Results of Operations

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

September 30
2017
 
June 30
2017
 
March 31
2017
 
December 31
2016
 
September 30
2016
INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
Interest income
$
14,976

 
$
14,498

 
$
13,861

 
$
13,760

 
$
13,607

Interest expense
3,200

 
3,028

 
2,831

 
2,826

 
2,747

Net interest income
11,776

 
11,470

 
11,030

 
10,934

 
10,860

Provision for loan losses
49

 
9

 
27

 
(320
)
 
17

Noninterest income
2,698

 
2,788

 
2,616

 
3,187

 
2,946

Noninterest expenses
10,139

 
9,507

 
9,951

 
10,166

 
9,433

Federal income tax expense
750

 
898

 
532

 
493

 
763

Net Income
$
3,536

 
$
3,844

 
$
3,136

 
$
3,782

 
$
3,593

PER SHARE
 
 
 
 
 
 
 
 
 
Basic earnings
$
0.45

 
$
0.49

 
$
0.40

 
$
0.48

 
$
0.46

Diluted earnings
$
0.44

 
$
0.48

 
$
0.39

 
$
0.47

 
$
0.45

Dividends
$
0.26

 
$
0.25

 
$
0.25

 
$
0.25

 
$
0.25

Tangible book value*
$
18.82

 
$
18.62

 
$
18.34

 
$
18.16

 
$
17.93

Quoted market value
 
 
 
 
 
 
 
 
 
High
$
29.10

 
$
28.45

 
$
29.00

 
$
28.35

 
$
28.08

Low
$
27.65

 
$
27.60

 
$
27.60

 
$
27.60

 
$
27.60

Close*
$
29.00

 
$
28.00

 
$
27.60

 
$
27.85

 
$
27.70

Common shares outstanding*
7,856,664

 
7,862,553

 
7,843,120

 
7,821,069

 
7,833,481

PERFORMANCE RATIOS
 
 
 
 
 
 
 
 
 
Return on average total assets
0.79
%
 
0.87
%
 
0.72
%
 
0.88
%
 
0.85
%
Return on average shareholders' equity
7.11
%
 
7.85
%
 
6.56
%
 
7.77
%
 
7.27
%
Return on average tangible shareholders' equity
9.61
%
 
10.59
%
 
8.77
%
 
10.70
%
 
10.28
%
Net interest margin yield (FTE)
3.08
%
 
3.03
%
 
2.99
%
 
3.01
%
 
3.05
%
BALANCE SHEET DATA*
 
 
 
 
 
 
 
 
 
Gross loans
$
1,077,544

 
$
1,048,497

 
$
1,012,920

 
$
1,010,615

 
$
989,366

AFS securities
$
552,925

 
$
567,862

 
$
590,114

 
$
558,096

 
$
564,229

Total assets
$
1,791,967

 
$
1,777,298

 
$
1,760,860

 
$
1,732,151

 
$
1,706,498

Deposits
$
1,216,062

 
$
1,210,152

 
$
1,231,061

 
$
1,195,040

 
$
1,175,833

Borrowed funds
$
367,027

 
$
360,940

 
$
327,375

 
$
337,694

 
$
325,409

Shareholders' equity
$
196,463

 
$
195,070

 
$
190,976

 
$
187,899

 
$
195,184

Gross loans to deposits
88.61
%
 
86.64
%
 
82.28
%
 
84.57
%
 
84.14
%
ASSETS UNDER MANAGEMENT*
 
 
 
 
 
 
 
 
 
Loans sold with servicing retained
$
268,817

 
$
269,595

 
$
270,217

 
$
272,882

 
$
275,037

Assets managed by our Investment and Trust Services Department
$
467,601

 
$
454,294

 
$
444,749

 
$
427,693

 
$
424,573

Total assets under management
$
2,528,385

 
$
2,501,187

 
$
2,475,826

 
$
2,432,726

 
$
2,406,108

ASSET QUALITY*
 
 
 
 
 
 
 
 
 
Nonperforming loans to gross loans
0.21
%
 
0.26
%
 
0.24
%
 
0.17
%
 
0.16
%
Nonperforming assets to total assets
0.14
%
 
0.17
%
 
0.15
%
 
0.11
%
 
0.11
%
ALLL to gross loans
0.71
%
 
0.72
%
 
0.74
%
 
0.73
%
 
0.79
%
CAPITAL RATIOS*
 
 
 
 
 
 
 
 
 
Shareholders' equity to assets
10.96
%
 
10.98
%
 
10.85
%
 
10.85
%
 
11.44
%
Tier 1 leverage
8.50
%
 
8.50
%
 
8.54
%
 
8.56
%
 
8.59
%
Common equity tier 1 capital
12.20
%
 
12.43
%
 
12.49
%
 
12.39
%
 
12.41
%
Tier 1 risk-based capital
12.20
%
 
12.43
%
 
12.49
%
 
12.39
%
 
12.41
%
Total risk-based capital
12.84
%
 
13.07
%
 
13.14
%
 
13.04
%
 
13.10
%
* At end of period

42

Table of Contents

The following table outlines our year-to-date results of operations and provides certain performance measures as of, and for the nine month periods ended:

September 30
2017
 
September 30
2016
 
September 30
2015
 
September 30
2014
 
September 30
2013
INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
Interest income
$
43,335

 
$
39,906

 
$
38,479

 
$
38,118

 
$
37,695

Interest expense
9,059

 
8,039

 
7,586

 
7,466

 
8,338

Net interest income
34,276

 
31,867

 
30,893

 
30,652

 
29,357

Provision for loan losses
85

 
185

 
(1,999
)
 
(604
)
 
866

Noninterest income
8,102

 
7,921

 
7,858

 
6,899

 
8,045

Noninterest expenses
29,597

 
27,731

 
26,166

 
26,180

 
25,057

Federal income tax expense
2,180

 
1,855

 
2,750

 
1,696

 
1,893

Net Income
$
10,516

 
$
10,017


$
11,834

 
$
10,279

 
$
9,586

PER SHARE
 
 
 
 
 
 
 
 
 
Basic earnings
$
1.34

 
$
1.28

 
$
1.52

 
$
1.33

 
$
1.25

Diluted earnings
$
1.31

 
$
1.25

 
$
1.49

 
$
1.30

 
$
1.22

Dividends
$
0.76

 
$
0.73

 
$
0.70

 
$
0.66

 
$
0.63

Tangible book value*
$
18.82

 
$
17.93

 
$
17.06

 
$
16.33

 
$
15.43

Quoted market value
 
 
 
 
 
 
 
 
 
High
$
29.10

 
$
29.90

 
$
23.85

 
$
24.00

 
$
26.00

Low
$
27.60

 
$
27.25

 
$
22.00

 
$
21.73

 
$
21.55

Close*
$
29.00

 
$
27.70

 
$
23.69

 
$
23.60

 
$
24.85

Common shares outstanding*
7,856,664

 
7,833,481

 
7,765,333

 
7,740,730

 
7,709,781

PERFORMANCE RATIOS
 
 
 
 
 
 
 
 
 
Return on average total assets
0.79
%
 
0.80
%
 
1.00
%
 
0.90
%
 
0.89
%
Return on average shareholders' equity
7.18
%
 
6.90
%
 
8.80
%
 
8.13
%
 
7.84
%
Return on average tangible shareholders' equity
9.67
%
 
9.68
%
 
12.06
%
 
10.95
%
 
11.02
%
Net interest margin yield (FTE)
3.03
%
 
3.00
%
 
3.12
%
 
3.20
%
 
3.22
%
BALANCE SHEET DATA*
 
 
 
 
 
 
 
 
 
Gross loans
$
1,077,544

 
$
989,366

 
$
836,671

 
$
825,238

 
$
810,335

AFS securities
$
552,925

 
$
564,229

 
$
628,612

 
$
575,080

 
$
501,057

Total assets
$
1,791,967

 
$
1,706,498

 
$
1,619,250

 
$
1,553,974

 
$
1,459,341

Deposits
$
1,216,062

 
$
1,175,833

 
$
1,128,003

 
$
1,081,890

 
$
1,023,931

Borrowed funds
$
367,027

 
$
325,409

 
$
297,610

 
$
290,438

 
$
266,001

Shareholders' equity
$
196,463

 
$
195,184

 
$
182,998

 
$
172,076

 
$
161,305

Gross loans to deposits
88.61
%
 
84.14
%
 
74.17
%
 
76.28
%
 
79.14
%
ASSETS UNDER MANAGEMENT*
 
 
 
 
 
 
 
 
 
Loans sold with servicing retained
$
268,817

 
$
275,037

 
$
289,268

 
$
290,697

 
$
294,999

Assets managed by our Investment and Trust Services Department
$
467,601

 
$
424,573

 
$
392,124

 
$
374,878

 
$
351,505

Total assets under management
$
2,528,385

 
$
2,406,108

 
$
2,300,642

 
$
2,219,549

 
$
2,105,845

ASSET QUALITY*
 
 
 
 
 
 
 
 
 
Nonperforming loans to gross loans
0.21
%
 
0.16
%
 
0.10
%
 
0.56
%
 
0.53
%
Nonperforming assets to total assets
0.14
%
 
0.11
%
 
0.09
%
 
0.37
%
 
0.37
%
ALLL to gross loans
0.71
%
 
0.79
%
 
0.98
%
 
1.26
%
 
1.44
%
CAPITAL RATIOS*
 
 
 
 
 
 
 
 
 
Shareholders' equity to assets
10.96
%
 
11.44
%
 
11.30
%
 
11.07
%
 
11.05
%
Tier 1 leverage
8.50
%
 
8.59
%
 
8.54
%
 
8.47
%
 
8.45
%
Common equity tier 1 capital
12.20
%
 
12.41
%
 
13.57
%
 
N/A

 
N/A

Tier 1 risk-based capital
12.20
%
 
12.41
%
 
13.57
%
 
13.86
%
 
13.75
%
Total risk-based capital
12.84
%
 
13.10
%
 
14.20
%
 
15.11
%
 
15.00
%
* At end of period

43

Table of Contents

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, non-earning 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. Loans in nonaccrual status, 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.

Three Months Ended

September 30, 2017

June 30, 2017

September 30, 2016

Average
Balance

Tax
Equivalent
Interest

Average
Yield /
Rate

Average
Balance

Tax
Equivalent
Interest

Average
Yield /
Rate

Average
Balance

Tax
Equivalent
Interest

Average
Yield /
Rate
INTEREST EARNING ASSETS

















Loans
$
1,062,439


$
11,297


4.25
%

$
1,028,875


$
10,685


4.15
%

$
948,465


$
9,965


4.20
%
Taxable investment securities
353,266


2,075


2.35
%

374,156


2,226


2.38
%

365,612


2,037


2.23
%
Nontaxable investment securities
202,180


2,302


4.55
%

206,668


2,314


4.48
%

203,236


2,312


4.55
%
Fed Funds Sold
4

 

 
%
 
95

 

 
%
 

 

 
%
Other
27,086


198


2.92
%

23,299


174


2.99
%

25,134


194


3.09
%
Total earning assets
1,644,975


15,872


3.86
%

1,633,093


15,399


3.77
%

1,542,447


14,508


3.76
%
NONEARNING ASSETS

















Allowance for loan losses
(7,632
)





(7,554
)





(7,731
)




Cash and demand deposits due from banks
19,919






18,425






18,672





Premises and equipment
28,859






28,895






28,865





Accrued income and other assets
101,417






99,468






104,125





Total assets
$
1,787,538






$
1,772,327






$
1,686,378





INTEREST BEARING LIABILITIES

















Interest bearing demand deposits
$
218,570


$
64


0.12
%

$
209,638


$
55


0.10
%

$
203,994


$
41


0.08
%
Savings deposits
360,689


303


0.34
%

360,870


259


0.29
%

330,872


178


0.22
%
Time deposits
428,758


1,348


1.26
%

436,716


1,301


1.19
%

433,591


1,277


1.18
%
Borrowed funds
361,706


1,485


1.64
%

356,096


1,413


1.59
%

314,218


1,251


1.59
%
Total interest bearing liabilities
1,369,723


3,200


0.93
%

1,363,320


3,028


0.89
%

1,282,675


2,747


0.86
%
NONINTEREST BEARING LIABILITIES

















Demand deposits
208,078






202,597






196,682





Other
10,763






10,579






9,332





Shareholders’ equity
198,974






195,831






197,689





Total liabilities and shareholders’ equity
$
1,787,538






$
1,772,327






$
1,686,378





Net interest income (FTE)


$
12,672






$
12,371






$
11,761



Net yield on interest earning assets (FTE)




3.08
%





3.03
%





3.05
%

44

Table of Contents

 
Nine Months Ended
 
September 30, 2017
 
September 30, 2016

Average
Balance
 
Tax
Equivalent
Interest
 
Average
Yield /
Rate
 
Average
Balance
 
Tax
Equivalent
Interest
 
Average
Yield /
Rate
INTEREST EARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
Loans
$
1,029,824

 
$
32,102

 
4.16
%
 
$
900,021

 
$
28,320

 
4.20
%
Taxable investment securities
363,851

 
6,452

 
2.36
%
 
405,722

 
6,740

 
2.21
%
Nontaxable investment securities
204,728

 
6,929

 
4.51
%
 
207,769

 
7,091

 
4.55
%
Fed Funds Sold
823

 
4

 
0.65
%
 

 

 
%
Other
25,796

 
543

 
2.81
%
 
25,208

 
509

 
2.69
%
Total earning assets
1,625,022

 
46,030

 
3.78
%
 
1,538,720

 
42,660

 
3.70
%
NONEARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses
(7,556
)
 
 
 
 
 
(7,576
)
 
 
 
 
Cash and demand deposits due from banks
19,003

 
 
 
 
 
18,130

 
 
 
 
Premises and equipment
28,996

 
 
 
 
 
28,495

 
 
 
 
Accrued income and other assets
99,537

 
 
 
 
 
102,072

 
 
 
 
Total assets
$
1,765,002

 
 
 
 
 
$
1,679,841

 
 
 
 
INTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
$
213,960

 
$
172

 
0.11
%
 
$
205,444

 
$
123

 
0.08
%
Savings deposits
358,544

 
784

 
0.29
%
 
337,863

 
466

 
0.18
%
Time deposits
433,799

 
3,914

 
1.20
%
 
427,441

 
3,724

 
1.16
%
Borrowed funds
348,846

 
4,189

 
1.60
%
 
315,061

 
3,726

 
1.58
%
Total interest bearing liabilities
1,355,149

 
9,059

 
0.89
%
 
1,285,809

 
8,039

 
0.83
%
NONINTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
203,784

 
 
 
 
 
191,082

 
 
 
 
Other
10,729

 
 
 
 
 
9,435

 
 
 
 
Shareholders’ equity
195,340

 
 
 
 
 
193,515

 
 
 
 
Total liabilities and shareholders’ equity
$
1,765,002

 
 
 
 
 
$
1,679,841

 
 
 
 
Net interest income (FTE)
 
 
$
36,971

 
 
 
 
 
$
34,621

 
 
Net yield on interest earning assets (FTE)
 
 
 
 
3.03
%
 
 
 
 
 
3.00
%
Net Interest Income
Net interest income is the amount by which interest income on earning assets exceeds the interest expenses on interest bearing liabilities. Net interest income, which includes loan fees, is influenced by changes in the balance and mix of assets and liabilities and market interest rates. We exert some control over these factors; however, FRB monetary policy and competition have a significant impact. For analytical purposes, net interest income is adjusted to an FTE basis by adding the income tax savings from interest on tax exempt loans, and nontaxable investment securities, thus making year to year comparisons more meaningful.
Volume and Rate Variance Analysis
The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. For the purpose of this table, changes in interest due to volume and rate were determined as follows:
Volume—change in volume multiplied by the previous period's rate.
Rate—change in the FTE rate multiplied by the previous period's volume.

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Table of Contents

The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
 
Three Months Ended 
 September 30, 2017 Compared to 
 June 30, 2017 
 Increase (Decrease) Due to
 
Three Months Ended 
 September 30, 2017 Compared to  
 September 30, 2016 
  Increase (Decrease) Due to
 
Nine Months Ended 
 September 30, 2017 Compared to 
 September 30, 2016 
 Increase (Decrease) Due to

Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Changes in interest income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans
$
353

 
$
259

 
$
612

 
$
1,211

 
$
121

 
$
1,332

 
$
4,049

 
$
(267
)
 
$
3,782

Taxable investment securities
(123
)
 
(28
)
 
(151
)
 
(70
)
 
108

 
38

 
(724
)
 
436

 
(288
)
Nontaxable investment securities
(51
)
 
39

 
(12
)
 
(12
)
 
2

 
(10
)
 
(103
)
 
(59
)
 
(162
)
Fed Funds Sold

 

 

 

 

 

 
4

 

 
4

Other
28

 
(4
)
 
24

 
15

 
(11
)
 
4

 
12

 
22

 
34

Total changes in interest income
207

 
266

 
473

 
1,144

 
220

 
1,364

 
3,238

 
132

 
3,370

Changes in interest expense
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
2

 
7

 
9

 
3

 
20

 
23

 
5

 
44

 
49

Savings deposits

 
44

 
44

 
17

 
108

 
125

 
30

 
288

 
318

Time deposits
(24
)
 
71

 
47

 
(14
)
 
85

 
71

 
56

 
134

 
190

Borrowed funds
23

 
49

 
72

 
194

 
40

 
234

 
405

 
58

 
463

Total changes in interest expense
1

 
171

 
172

 
200

 
253

 
453

 
496

 
524

 
1,020

Net change in interest margin (FTE)
$
206

 
$
95

 
$
301

 
$
944

 
$
(33
)
 
$
911

 
$
2,742

 
$
(392
)
 
$
2,350

While our net yield on interest earning assets increased during the quarter, yields continue to be at low levels. The persistent low interest rate environment coupled with a high concentration of AFS securities as a percentage of earning assets has also placed downward pressure on net interest margin. While we do not anticipate significant improvement in our net yield on interest earning assets, we do expect marginal improvement as a result of loan growth throughout 2017.
 
Average Yield / Rate for the Three Month Periods Ended:

September 30
2017

June 30
2017

March 31
2017

December 31
2016

September 30
2016
Total earning assets
3.86
%
 
3.77
%
 
3.70
%
 
3.73
%
 
3.76
%
Total interest bearing liabilities
0.93
%
 
0.89
%
 
0.85
%
 
0.87
%
 
0.86
%
Net yield on interest earning assets (FTE)
3.08
%

3.03
%
 
2.99
%
 
3.01
%
 
3.05
%
 
Quarter to Date Net Interest Income (FTE)

September 30
2017
 
June 30
2017
 
March 31
2017
 
December 31
2016
 
September 30
2016
Total interest income (FTE)
$
15,872

 
$
15,399

 
$
14,759

 
$
14,642

 
$
14,508

Total interest expense
3,200

 
3,028

 
2,831

 
2,826

 
2,747

Net interest income (FTE)
$
12,672

 
$
12,371

 
$
11,928

 
$
11,816

 
$
11,761


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Table of Contents

Allowance for Loan and Lease Losses
The viability of any financial institution is ultimately determined by its management of credit risk. Loans represent our single largest concentration of risk. The ALLL is our estimation of incurred losses within the existing loan portfolio. We allocate the ALLL throughout the loan portfolio based on our assessment of the underlying risks associated with each loan segment. Our assessments include allocations based on specific impairment valuation allowances, historical charge-offs, internally assigned credit risk ratings, and past due and nonaccrual balances. A portion of the ALLL is not allocated to any one loan segment, but is instead a representation of other qualitative risks that reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
The following table summarizes our charge-offs, recoveries, provisions for loan losses, and ALLL balances as of, and for the:
 
Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30

2017
 
2016
 
2017
 
2016
ALLL at beginning of period
$
7,600

 
$
7,600

 
$
7,400

 
$
7,400

Charge-offs
 
 
 
 
 
 
 
Commercial and agricultural
8

 

 
60

 
48

Residential real estate
77

 
57

 
120

 
426

Consumer
72

 
74

 
190

 
206

Total charge-offs
157

 
131

 
370

 
680

Recoveries
 
 
 
 
 
 
 
Commercial and agricultural
134

 
118

 
322

 
488

Residential real estate
41

 
153

 
140

 
248

Consumer
33

 
43

 
123

 
159

Total recoveries
208

 
314

 
585

 
895

Net loan charge-offs (recoveries)
(51
)
 
(183
)
 
(215
)
 
(215
)
Provision for loan losses
49

 
17

 
85

 
185

ALLL at end of period
$
7,700

 
$
7,800

 
$
7,700

 
$
7,800

Net loan charge-offs (recoveries) to average loans outstanding
%
 
(0.02
)%
 
(0.02
)%
 
(0.02
)%
The following table summarizes our charge-offs, recoveries, provisions for loan losses, and ALLL balances as of, and for the three month periods ended:

September 30
2017
 
June 30
2017
 
March 31
2017
 
December 31
2016
 
September 30
2016
Total charge-offs
$
157

 
$
69

 
$
144

 
$
236

 
$
131

Total recoveries
208

 
160

 
217

 
156

 
314

Net loan charge-offs (recoveries)
(51
)
 
(91
)
 
(73
)
 
80

 
(183
)
Net loan charge-offs (recoveries) to average loans outstanding
 %
 
(0.01
)%
 
(0.01
)%
 
0.01
 %
 
(0.02
)%
Provision for loan losses
$
49

 
$
9

 
$
27

 
$
(320
)
 
$
17

Provision for loan losses to average loans outstanding
 %
 
 %
 
 %
 
(0.03
)%
 
 %
ALLL
$
7,700

 
$
7,600

 
$
7,500

 
$
7,400

 
$
7,800

ALLL as a % of loans at end of period
0.71
 %
 
0.72
 %
 
0.74
 %
 
0.73
 %
 
0.79
 %
Net loan recoveries and the continuation of strong credit quality indicators have resulted in a reduction of the required ALLL as a percentage of loans over the past year. During this time, credit quality indicators, specifically historical loss factors, remain strong and have led to lower levels of required reserves. While the ALLL as a percentage of loans has declined, the balance of the ALLL has increased in recent periods as a result of our strong loan growth. The addition of advances to mortgage brokers contributed to the overall decline in the level of ALLL to gross loans as there are no historical losses requiring reserves. While these advances contribute to other qualitative factors, the impact is not significant on the required level of the ALLL.

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Table of Contents

The following table illustrates our changes within the two main components of the ALLL as of:

September 30
2017
 
June 30
2017
 
March 31
2017
 
December 31
2016
 
September 30
2016
ALLL
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,551

 
$
2,455

 
$
2,381

 
$
2,371

 
$
2,523

Collectively evaluated for impairment
5,149

 
5,145

 
5,119

 
5,029

 
5,277

Total
$
7,700

 
$
7,600

 
$
7,500

 
$
7,400

 
$
7,800

ALLL to gross loans
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
0.24
%
 
0.23
%
 
0.24
%
 
0.23
%
 
0.26
%
Collectively evaluated for impairment
0.47
%
 
0.49
%
 
0.50
%
 
0.50
%
 
0.53
%
Total
0.71
%
 
0.72
%
 
0.74
%
 
0.73
%
 
0.79
%
For further discussion of the allocation of the ALLL, see “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
Loans Past Due and Loans in Nonaccrual Status
Fluctuations in past due and nonaccrual status loans can have a significant impact on the ALLL. To determine the potential impact, and corresponding estimated losses, we analyze our historical loss trends on loans past due greater than 30 days and nonaccrual status loans. We monitor all loans that are past due and in nonaccrual status for indications of additional deterioration.
 
Total Past Due and Nonaccrual Loans

September 30
2017
 
June 30
2017
 
March 31
2017
 
December 31
2016
 
September 30
2016
Commercial and agricultural
$
3,600

 
$
4,920

 
$
5,758

 
$
4,598

 
$
3,148

Residential real estate
2,201

 
2,358

 
3,168

 
2,716

 
2,436

Consumer
52

 
64

 
35

 
115

 
51

Total
$
5,853

 
$
7,342

 
$
8,961

 
$
7,429

 
$
5,635

Total past due and nonaccrual loans to gross loans
0.54
%
 
0.70
%
 
0.88
%
 
0.74
%
 
0.57
%
While past due and nonaccrual status loans have fluctuated over the last year, they continue to be at low levels and are the result of strong loan performance. A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual status loans by type, is included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

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Table of Contents

Troubled Debt Restructurings
We have taken a proactive approach to avoid foreclosures on borrowers who are willing to work with us in modifying their loans, thus making them more affordable. While this approach has permitted certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure, it has contributed to a significant level of loans classified as TDR. The modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. At the time of the TDR, the loan is reviewed to determine whether or not to classify the loan as accrual or nonaccrual status. The majority of new modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed on nonaccrual status may be placed back on accrual status after six months of continued performance and achievement of current payment status.
We restructure debt with borrowers who, due to financial difficulties, are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, allow interest only payment structures, forgive principal, forgive interest, or a combination of these modifications. Typically, the modifications are for a period of five years or less. There were no TDRs that were government sponsored as of September 30, 2017 or December 31, 2016.
Losses associated with TDRs, if any, are included in the estimation of the ALLL in the quarter in which a loan is identified as a TDR, and we review the analysis of the ALLL estimation each reporting period to ensure its continued appropriateness.
The following tables provide a roll-forward of TDRs for the:

Three Months Ended September 30, 2017
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
July 1, 2017
155

 
$
25,182

 
5

 
$
1,159

 
160

 
$
26,341

New modifications
3

 
1,354

 
2

 
210

 
5

 
1,564

Principal advances (payments)

 
(165
)
 

 
(12
)
 

 
(177
)
Loans paid-off
(6
)
 
(460
)
 

 

 
(6
)
 
(460
)
Partial charge-offs

 

 

 

 

 

Balances charged-off
(1
)
 
(9
)
 

 

 
(1
)
 
(9
)
Transfers to OREO

 

 

 

 

 

Transfers to accrual status
1

 
51

 
(1
)
 
(51
)
 

 

Transfers to nonaccrual status

 

 

 

 

 

September 30, 2017
152

 
$
25,953

 
6

 
$
1,306

 
158

 
$
27,259


Nine Months Ended September 30, 2017
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
January 1, 2017
153

 
$
20,593

 
5

 
$
789

 
158

 
$
21,382

New modifications
16

 
6,909

 
3

 
676

 
19

 
7,585

Principal advances (payments)

 
(587
)
 

 
(34
)
 

 
(621
)
Loans paid-off
(16
)
 
(987
)
 

 

 
(16
)
 
(987
)
Partial charge-offs

 

 

 

 

 

Balances charged-off
(1
)
 
(9
)
 

 

 
(1
)
 
(9
)
Transfers to OREO

 

 
(2
)
 
(91
)
 
(2
)
 
(91
)
Transfers to accrual status
2

 
126

 
(2
)
 
(126
)
 

 

Transfers to nonaccrual status
(2
)
 
(92
)
 
2

 
92

 

 

September 30, 2017
152

 
$
25,953

 
6

 
$
1,306

 
158

 
$
27,259


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Table of Contents


Three Months Ended September 30, 2016
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
July 1, 2016
151

 
$
18,843

 
6

 
$
587

 
157

 
$
19,430

New modifications
3

 
1,634

 

 

 
3

 
1,634

Principal advances (payments)

 
(204
)
 

 
(9
)
 

 
(213
)
Loans paid-off
(5
)
 
(272
)
 

 

 
(5
)
 
(272
)
Partial charge-offs

 

 

 

 

 

Balances charged-off
(1
)
 
(57
)
 

 

 
(1
)
 
(57
)
Transfers to OREO

 

 

 

 

 

Transfers to accrual status
3

 
218

 
(3
)
 
(218
)
 

 

Transfers to nonaccrual status
(2
)
 
(103
)
 
2

 
103

 

 

September 30, 2016
149

 
$
20,059

 
5

 
$
463

 
154

 
$
20,522


Nine Months Ended September 30, 2016
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
January 1, 2016
155

 
$
20,931

 
5

 
$
394

 
160

 
$
21,325

New modifications
9

 
1,863

 

 

 
9

 
1,863

Principal advances (payments)

 
(831
)
 

 
(26
)
 

 
(857
)
Loans paid-off
(11
)
 
(1,348
)
 
(1
)
 
(221
)
 
(12
)
 
(1,569
)
Partial charge-offs

 

 

 
(133
)
 

 
(133
)
Balances charged-off
(2
)
 
(72
)
 

 

 
(2
)
 
(72
)
Transfers to OREO

 

 
(1
)
 
(35
)
 
(1
)
 
(35
)
Transfers to accrual status
3

 
218

 
(3
)
 
(218
)
 

 

Transfers to nonaccrual status
(5
)
 
(702
)
 
5

 
702

 

 

September 30, 2016
149

 
$
20,059

 
5

 
$
463

 
154

 
$
20,522

The following table summarizes our TDRs as of:
 
September 30, 2017
 
December 31, 2016
 
 

Accruing
Interest
 
Nonaccrual
 
Total
 
Accruing
Interest
 
Nonaccrual
 
Total
 
Total
Change
Current
$
24,641

 
$
233

 
$
24,874

 
$
17,557

 
$
559

 
$
18,116

 
$
6,758

Past due 30-59 days
1,086

 
216

 
1,302

 
2,898

 
230

 
3,128

 
(1,826
)
Past due 60-89 days
3

 

 
3

 
138

 

 
138

 
(135
)
Past due 90 days or more
223

 
857

 
1,080

 

 

 

 
1,080

Total
$
25,953

 
$
1,306

 
$
27,259

 
$
20,593

 
$
789

 
$
21,382

 
$
5,877

Additional disclosures about TDRs are included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

50

Table of Contents

Impaired Loans
The following is a summary of information pertaining to impaired loans as of:
 
September 30, 2017
 
December 31, 2016

Recorded
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
 
Recorded
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
TDRs
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
6,062

 
$
6,181

 
$
766

 
$
6,264

 
$
6,383

 
$
713

Commercial other
2,324

 
2,324

 
167

 
1,444

 
1,455

 
25

Agricultural real estate
7,834

 
7,834

 

 
4,037

 
4,037

 

Agricultural other
3,014

 
3,014

 

 
1,380

 
1,380

 
1

Residential real estate senior liens
7,854

 
8,234

 
1,524

 
8,058

 
8,437

 
1,539

Residential real estate junior liens
70

 
70

 
13

 
71

 
71

 
13

Home equity lines of credit
83

 
383

 

 
102

 
402

 

Consumer secured
18

 
18

 

 
26

 
26

 

Total TDRs
27,259

 
28,058

 
2,470

 
21,382

 
22,191

 
2,291

Other impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
136

 
210

 

 
151

 
226

 
3

Commercial other
3

 
3

 

 

 

 

Agricultural real estate

 

 

 

 

 

Agricultural other
128

 
128

 

 
128

 
128

 

Residential real estate senior liens
419

 
669

 
81

 
406

 
612

 
76

Residential real estate junior liens

 

 

 
1

 
11

 
1

Home equity lines of credit

 

 

 

 

 

Consumer secured

 

 

 

 

 

Total other impaired loans
686

 
1,010

 
81

 
686

 
977

 
80

Total impaired loans
$
27,945

 
$
29,068

 
$
2,551

 
$
22,068

 
$
23,168

 
$
2,371

Additional disclosure related to impaired loans is included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

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Table of Contents

Nonperforming Assets
The following table summarizes our nonperforming assets as of:

September 30
2017
 
June 30
2017
 
March 31
2017
 
December 31
2016
 
September 30
2016
Nonaccrual status loans
$
1,605

 
$
1,563

 
$
1,138

 
$
1,060

 
$
690

Accruing loans past due 90 days or more
646

 
1,203

 
1,339

 
633

 
847

Total nonperforming loans
2,251

 
2,766

 
2,477

 
1,693

 
1,537

Foreclosed assets
240

 
229

 
158

 
231

 
284

Total nonperforming assets
$
2,491

 
$
2,995

 
$
2,635

 
$
1,924

 
$
1,821

Nonperforming loans as a % of total loans
0.21
%
 
0.26
%
 
0.24
%
 
0.17
%
 
0.16
%
Nonperforming assets as a % of total assets
0.14
%
 
0.17
%
 
0.15
%
 
0.11
%
 
0.11
%
Typically after a loan is 90 days past due, it is placed on nonaccrual status unless it is well secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Loans may be placed back on accrual status after six months of continued performance and achievement of current payment status. Nonperforming loans have declined in recent periods with current levels of nonperforming loans continuing to be at low levels.
Included in the nonaccrual loan balances above were loans currently classified as TDR as of:

September 30
2017
 
December 31
2016
Commercial and agricultural
$
1,068

 
$
405

Residential real estate
238

 
384

Total
$
1,306

 
$
789

Additional disclosures about nonaccrual status loans are included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recording of a charge-off. We believe that we have identified all impaired loans as of September 30, 2017.
We believe that the level of the ALLL is appropriate as of September 30, 2017. We will continue to closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at the appropriate level.

52

Table of Contents

Noninterest Income and Noninterest Expenses
Significant noninterest income account balances are highlighted in the following table with additional descriptions of significant fluctuations:

Three Months Ended September 30
 
 
 
 
 
Change
 
2017
 
2016
 
$
 
%
Service charges and fees
 
 
 
 
 
 
 
ATM and debit card fees
$
667

 
$
606

 
$
61

 
10.07
 %
NSF and overdraft fees
481

 
480

 
1

 
0.21
 %
Freddie Mac servicing fee
169

 
172

 
(3
)
 
(1.74
)%
Service charges on deposit accounts
88

 
92

 
(4
)
 
(4.35
)%
Net OMSR income (loss)
(77
)
 
(108
)
 
31

 
28.70
 %
All other
107

 
34

 
73

 
214.71
 %
Total service charges and fees
1,435

 
1,276

 
159

 
12.46
 %
Net gain on sale of mortgage loans
153

 
263

 
(110
)
 
(41.83
)%
Earnings on corporate owned life insurance policies
174

 
183

 
(9
)
 
(4.92
)%
Net gains (losses) on sale of AFS securities

 

 

 
 %
Other
 
 
 
 
 
 
 
Trust and brokerage advisory fees
724

 
1,000

 
(276
)
 
(27.60
)%
Corporate Settlement Solutions joint venture
84

 
145

 
(61
)
 
(42.07
)%
Other
128

 
79

 
49

 
62.03
 %
Total other
936

 
1,224

 
(288
)
 
(23.53
)%
Total noninterest income
$
2,698

 
$
2,946

 
$
(248
)
 
(8.42
)%

Nine Months Ended September 30
 
 
 
 
 
Change
 
2017
 
2016
 
$
 
%
Service charges and fees
 
 
 
 
 
 
 
ATM and debit card fees
$
1,945

 
$
1,840

 
$
105

 
5.71
 %
NSF and overdraft fees
1,383

 
1,360

 
23

 
1.69
 %
Freddie Mac servicing fee
508

 
529

 
(21
)
 
(3.97
)%
Service charges on deposit accounts
259

 
263

 
(4
)
 
(1.52
)%
Net OMSR income (loss)
107

 
(437
)
 
544

 
124.49
 %
All other
168

 
97

 
71

 
73.20
 %
Total service charges and fees
4,370

 
3,652

 
718

 
19.66
 %
Net gain on sale of mortgage loans
507

 
472

 
35

 
7.42
 %
Earnings on corporate owned life insurance policies
537

 
566

 
(29
)
 
(5.12
)%
Net gains (losses) on sale of AFS securities
142

 
245

 
(103
)
 
(42.04
)%
Other
 
 
 
 
 
 
 
Trust and brokerage advisory fees
1,961

 
2,135

 
(174
)
 
(8.15
)%
Corporate Settlement Solutions joint venture
171

 
362

 
(191
)
 
(52.76
)%
Other
414

 
489

 
(75
)
 
(15.34
)%
Total other
2,546

 
2,986

 
(440
)
 
(14.74
)%
Total noninterest income
$
8,102

 
$
7,921

 
$
181

 
2.29
 %



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Table of Contents

Significant changes in noninterest income are detailed below:
Offering rates on residential mortgage loans and prepayment speeds have been the most significant drivers behind fluctuations in net OMSR income (loss). We anticipate increases in mortgage rates and decreased prepayment speeds; therefore, we anticipate year-to-date net OMSR income to be positive during the remainder of 2017.
We anticipate increases in our originations in purchase money mortgage activity as a result of our various initiatives to drive growth. As a result, we expect net gains on the sale of mortgage loans to increase during the remainder of 2017.
We continue to invest considerable efforts to increase our market share in trust and brokerage advisory services. These efforts have translated into increases in such fee income. We anticipate that fee income will continue to increase during the remainder of 2017; however, 2017 year-to-date income will remain lower than income in 2016 due to a fee income assessment change during the third quarter of 2016 which resulted in higher earnings in 2016.
Corporate Settlement Solutions income is down in 2017 compared to 2016 resulting from decreased revenue related to lower levels of loan origination and refinancing activities. Year-to-date income for 2017 is expected to continue to fall below 2016 levels.
The fluctuations in all other income is spread throughout various categories, none of which are individually significant.

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Table of Contents

Significant noninterest expense account balances are highlighted in the following table with additional descriptions of significant fluctuations:
 
Three Months Ended September 30

 
 
 
 
Change
 
2017
 
2016
 
$
 
%
Compensation and benefits
 
 
 
 
 
 
 
Employee salaries
$
4,005

 
$
3,610

 
$
395

 
10.94
 %
Employee benefits
1,355

 
1,330

 
25

 
1.88
 %
Total compensation and benefits
5,360

 
4,940

 
420

 
8.50
 %
Furniture and equipment
 
 
 
 
 
 
 
Service contracts
814

 
825

 
(11
)
 
(1.33
)%
Depreciation
511

 
483

 
28

 
5.80
 %
All other
52

 
45

 
7

 
15.56
 %
Total furniture and equipment
1,377

 
1,353

 
24

 
1.77
 %
Occupancy
 
 
 
 
 
 
 
Depreciation
212

 
195

 
17

 
8.72
 %
Outside services
178

 
171

 
7

 
4.09
 %
Property taxes
142

 
141

 
1

 
0.71
 %
Utilities
132

 
168

 
(36
)
 
(21.43
)%
All other
145

 
170

 
(25
)
 
(14.71
)%
Total occupancy
809

 
845

 
(36
)
 
(4.26
)%
Other
 
 
 
 
 
 
 
ATM and debit card fees
253

 
210

 
43

 
20.48
 %
Audit and related fees
322

 
319

 
3

 
0.94
 %
Consulting fees
259

 
198

 
61

 
30.81
 %
Director fees
212

 
207

 
5

 
2.42
 %
Loan underwriting fees
237

 
142

 
95

 
66.90
 %
Donations and community relations
190

 
134

 
56

 
41.79
 %
FDIC insurance premiums
172

 
224

 
(52
)
 
(23.21
)%
Marketing costs
172

 
101

 
71

 
70.30
 %
Education and travel
143

 
73

 
70

 
95.89
 %
Printing and supplies
110

 
105

 
5

 
4.76
 %
Postage and freight
85

 
96

 
(11
)
 
(11.46
)%
All other
438

 
486

 
(48
)
 
(9.88
)%
Total other
2,593

 
2,295

 
298

 
12.98
 %
Total noninterest expenses
$
10,139

 
$
9,433

 
$
706

 
7.48
 %

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Table of Contents

 
Nine Months Ended September 30

 
 
 
 
Change
 
2017
 
2016
 
$
 
%
Compensation and benefits
 
 
 
 
 
 
 
Employee salaries
$
12,127

 
$
10,387

 
$
1,740

 
16.75
 %
Employee benefits
3,742

 
4,025

 
(283
)
 
(7.03
)%
Total compensation and benefits
15,869

 
14,412

 
1,457

 
10.11
 %
Furniture and equipment
 
 
 
 
 
 
 
Service contracts
2,386

 
2,323

 
63

 
2.71
 %
Depreciation
1,531

 
1,533

 
(2
)
 
(0.13
)%
All other
156

 
132

 
24

 
18.18
 %
Total furniture and equipment
4,073

 
3,988

 
85

 
2.13
 %
Occupancy
 
 
 
 
 
 
 
Depreciation
632

 
583

 
49

 
8.40
 %
Outside services
577

 
555

 
22

 
3.96
 %
Property taxes
434

 
429

 
5

 
1.17
 %
Utilities
390

 
429

 
(39
)
 
(9.09
)%
All other
428

 
447

 
(19
)
 
(4.25
)%
Total occupancy
2,461

 
2,443

 
18

 
0.74
 %
Other
 
 
 
 
 
 
 
ATM and debit card fees
873

 
627

 
246

 
39.23
 %
Audit and related fees
757

 
664

 
93

 
14.01
 %
Consulting fees
672

 
567

 
105

 
18.52
 %
Director fees
634

 
630

 
4

 
0.63
 %
Loan underwriting fees
546

 
377

 
169

 
44.83
 %
Donations and community relations
488

 
399

 
89

 
22.31
 %
FDIC insurance premiums
480

 
646

 
(166
)
 
(25.70
)%
Marketing costs
361

 
359

 
2

 
0.56
 %
Education and travel
332

 
309

 
23

 
7.44
 %
Printing and supplies
320

 
325

 
(5
)
 
(1.54
)%
Postage and freight
304

 
293

 
11

 
3.75
 %
All other
1,427

 
1,692

 
(265
)
 
(15.66
)%
Total other
7,194

 
6,888

 
306

 
4.44
 %
Total noninterest expenses
$
29,597

 
$
27,731

 
$
1,866

 
6.73
 %
Significant changes in noninterest expenses are detailed below:
Employee salaries have increased in 2017 as a result of new positions required for future growth within our new markets, normal merit increases and increased incentive compensation. As such, we anticipate employee salaries expense to continue to trend higher for the remainder of 2017 compared to the expense levels of 2016.
Employee benefits have declined in 2017 due to a settlement with an insurance claim administrator in favor of Isabella Bank.
ATM and debit card fees have increased in 2017 due to an early contract termination fee.
Consulting fees have increased in 2017 due to compliance related services due to staff vacancies. Fees are expected to exceed 2016 levels for the remainder of 2017.
Loan underwriting fees have increased due to increased consumer loan originations. Fees are expected to increase during the remainder of 2017 and exceed 2016 levels.

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Table of Contents

FDIC insurance premiums have declined in 2017 as a result of changes to the premium calculation set forth by the FDIC in 2016; therefore, 2017 expenses are expected to be lower than 2016 for the remainder of the year.
The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.
Analysis of Changes in Financial Condition

September 30
2017
 
December 31
2016
 
$ Change
 
% Change
(unannualized)
ASSETS
 
 
 
 
 
 
 
Cash and cash equivalents
$
21,067

 
$
22,894

 
$
(1,827
)
 
(7.98
)%
AFS securities
 
 
 
 
 
 
 
Amortized cost of AFS securities
548,468

 
557,648

 
(9,180
)
 
(1.65
)%
Unrealized gains (losses) on AFS securities
4,457

 
448

 
4,009

 
N/M

AFS securities
552,925

 
558,096

 
(5,171
)
 
(0.93
)%
Mortgage loans AFS
1,237

 
1,816

 
(579
)
 
(31.88
)%
Loans
 
 
 
 


 
 
Gross loans
1,077,544

 
1,010,615

 
66,929

 
6.62
 %
Less allowance for loan and lease losses
7,700

 
7,400

 
300

 
4.05
 %
Net loans
1,069,844

 
1,003,215

 
66,629

 
6.64
 %
Premises and equipment
28,761

 
29,314

 
(553
)
 
(1.89
)%
Corporate owned life insurance policies
26,837

 
26,300

 
537

 
2.04
 %
Accrued interest receivable
7,388

 
6,580

 
808

 
12.28
 %
Equity securities without readily determinable fair values
23,461

 
21,694

 
1,767

 
8.15
 %
Goodwill and other intangible assets
48,575

 
48,666

 
(91
)
 
(0.19
)%
Other assets
11,872

 
13,576

 
(1,704
)
 
(12.55
)%
TOTAL ASSETS
$
1,791,967

 
$
1,732,151

 
$
59,816

 
3.45
 %
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Deposits
$
1,216,062

 
$
1,195,040

 
$
21,022

 
1.76
 %
Borrowed funds
367,027

 
337,694

 
29,333

 
8.69
 %
Accrued interest payable and other liabilities
12,415

 
11,518

 
897

 
7.79
 %
Total liabilities
1,595,504

 
1,544,252

 
51,252

 
3.32
 %
Shareholders’ equity
196,463

 
187,899

 
8,564

 
4.56
 %
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,791,967

 
$
1,732,151

 
$
59,816

 
3.45
 %
As shown above, total assets have increased $59,816 since December 31, 2016 which was primarily driven by loan growth of $66,929. This growth was funded by an increase in deposits and in borrowed funds of $21,022 and $29,333, respectively, since December 31, 2016. While generating quality loans will continue to be competitive, we expect that loans will continue to grow in 2017.
The following table outlines the changes in loans:

September 30
2017
 
December 31
2016
 
$ Change
 
% Change
(unannualized)
Commercial
$
620,135

 
$
575,664

 
$
44,471

 
7.73
%
Agricultural
132,998

 
126,492

 
6,506

 
5.14
%
Residential real estate
271,480

 
266,050

 
5,430

 
2.04
%
Consumer
52,931

 
42,409

 
10,522

 
24.81
%
Total
$
1,077,544

 
$
1,010,615

 
$
66,929

 
6.62
%

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Table of Contents

The following table displays loan balances as of:

September 30
2017
 
June 30
2017
 
March 31
2017
 
December 31
2016
 
September 30
2016
Commercial
$
620,135

 
$
600,584

 
$
576,822

 
$
575,664

 
$
554,847

Agricultural
132,998

 
130,954

 
126,049

 
126,492

 
133,637

Residential real estate
271,480

 
270,207

 
267,141

 
266,050

 
260,122

Consumer
52,931

 
46,752

 
42,908

 
42,409

 
40,760

Total
$
1,077,544

 
$
1,048,497

 
$
1,012,920

 
$
1,010,615

 
$
989,366

While competition for commercial loans continues to be strong, we experienced significant growth in these segments of the portfolio during 2016 and 2017 and anticipate continued growth in the remainder of 2017. Residential real estate and consumer loans have also experienced growth over the last year and are both expected to increase for the remainder of 2017.
The following table outlines the changes in deposits:

September 30
2017
 
December 31
2016
 
$ Change
 
% Change
(unannualized)
Noninterest bearing demand deposits
$
212,608

 
$
205,071

 
$
7,537

 
3.68
 %
Interest bearing demand deposits
220,601

 
209,325

 
11,276

 
5.39
 %
Savings deposits
358,358

 
347,230

 
11,128

 
3.20
 %
Certificates of deposit
309,778

 
321,914

 
(12,136
)
 
(3.77
)%
Brokered certificates of deposit
95,979

 
88,632

 
7,347

 
8.29
 %
Internet certificates of deposit
18,738

 
22,868

 
(4,130
)
 
(18.06
)%
Total
$
1,216,062

 
$
1,195,040

 
$
21,022

 
1.76
 %
The following table displays deposit balances as of:

September 30
2017
 
June 30
2017
 
March 31
2017
 
December 31
2016
 
September 30
2016
Noninterest bearing demand deposits
$
212,608

 
$
210,122

 
$
207,448

 
$
205,071

 
$
201,804

Interest bearing demand deposits
220,601

 
212,365

 
216,975

 
209,325

 
205,817

Savings deposits
358,358

 
357,756

 
365,287

 
347,230

 
331,414

Certificates of deposit
309,778

 
314,482

 
320,345

 
321,914

 
324,910

Brokered certificates of deposit
95,979

 
94,948

 
98,442

 
88,632

 
87,583

Internet certificates of deposit
18,738

 
20,479

 
22,564

 
22,868

 
24,305

Total
$
1,216,062

 
$
1,210,152

 
$
1,231,061

 
$
1,195,040

 
$
1,175,833

Deposit demand continues to be driven by non-contractual deposits, such as demand and savings deposits, while certificates of deposit and Internet certificates of deposit have gradually declined. Brokered certificates of deposit offer another source of funding and fluctuate from period-to-period based on our funding needs, including changes in assets such as loans and investments.

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Table of Contents

The balance of AFS securities fluctuates from period-to-period based on changes in loans and deposits. While loan growth has been strong over the last year, we purchased AFS securities in periods when deposit growth outpaced loan demand. Conversely, we have sold AFS securities in periods when loan demand has outpaced deposit growth. We remain active in investments with our local schools and municipalities. Potential future growth is anticipated in state and political subdivisions and purchases of mortgage-backed securities and collateralized mortgage obligations. The following table displays fair values of AFS securities as of:

September 30
2017
 
June 30
2017
 
March 31
2017
 
December 31
2016
 
September 30
2016
Government sponsored enterprises
$
232

 
$
281

 
$
10,264

 
$
10,259

 
$
344

States and political subdivisions
213,457

 
222,093

 
222,777

 
212,919

 
219,689

Auction rate money market preferred
3,172

 
3,095

 
2,977

 
2,794

 
3,145

Preferred stocks
3,651

 
3,665

 
3,597

 
3,425

 
3,588

Mortgage-backed securities
215,914

 
221,957

 
229,774

 
227,256

 
226,649

Collateralized mortgage obligations
116,499

 
116,771

 
120,725

 
101,443

 
110,814

Total
$
552,925

 
$
567,862

 
$
590,114

 
$
558,096

 
$
564,229

Borrowed funds include FHLB advances, securities sold under agreements to repurchase, and federal funds purchased. The balance of borrowed funds fluctuates from period-to-period based on our funding needs including changes in loans, investments, and deposits. To provide balance sheet growth, we utilize borrowings and brokered deposits to fund earning assets. The following table displays borrowed funds balances as of:

September 30
2017
 
June 30
2017
 
March 31
2017
 
December 31
2016
 
September 30
2016
FHLB advances
$
310,000

 
$
310,000

 
$
270,000

 
$
270,000

 
$
250,000

Securities sold under agreements to repurchase without stated maturity dates
54,977

 
49,950

 
57,375

 
60,894

 
54,809

Federal funds purchased
2,050

 
990

 

 
6,800

 
20,600

Total
$
367,027

 
$
360,940

 
$
327,375

 
$
337,694

 
$
325,409

Capital
Capital consists solely of common stock, retained earnings, and accumulated other comprehensive income (loss). We are authorized to raise capital through dividend reinvestment, employee and director stock purchases, and shareholder stock purchases. Pursuant to these authorizations, we issued 178,712 shares or $4,999 of common stock during the first nine months of 2017, as compared to 131,697 shares or $3,683 of common stock during the same period in 2016. We also offer the Directors Plan in which participants either directly purchase stock or purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $502 and $443 during the nine month periods ended September 30, 2017 and 2016, respectively.
We have a publicly announced common stock repurchase plan. Pursuant to this plan, we repurchased 143,117 shares or $4,005 of common stock during the first nine months of 2017 and 98,083 shares or $2,749 during the first nine months of 2016. As of September 30, 2017, we were authorized to repurchase up to an additional 56,839 shares of common stock.
The FRB has established minimum risk based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital. On July 2, 2013, the FRB published revised BASEL III Capital standards for banks. The final rules redefine what is included or deducted from equity capital, changes risk weighting for certain on and off-balance sheet assets, increases the minimum required equity capital to be considered well capitalized, and introduces a capital conservation buffer. The rules, which are being gradually phased in between 2015 and 2019, are not expected to have a material impact on the Corporation but will require us to hold more capital than has historically been required.
There are no significant regulatory constraints placed on our capital. The FRB’s current recommended minimum primary capital to assets requirement is 6.00%. Our primary capital to adjusted average assets, or tier 1 leverage ratio, was 8.50% as of September 30, 2017.

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Table of Contents

Effective January 1, 2015, the minimum standard for primary, or Tier 1 capital, increased from 4.00% to 6.00%. The minimum standard for total capital is 8.00%. Also effective January 1, 2015 was the new common equity tier 1 capital ratio which had a minimum requirement of 4.50%. Beginning on January 1, 2016 the capital conservation buffer went into effect which will further increase the required levels each year through 2019. The following table sets forth the percentages required under the Risk Based Capital guidelines and our ratios as of:
 
September 30
2017
 
December 31
2016

Actual
 
Minimum Required
 
Actual
 
Minimum Required
Common equity tier 1 capital
12.200
%
 
5.750
%
 
12.390
%
 
5.125
%
 
 
 
 
 
 
 
 
Tier 1 capital
12.200
%
 
7.250
%
 
12.390
%
 
6.625
%
Tier 2 capital
0.640
%
 
2.000
%
 
0.650
%
 
2.000
%
Total Capital
12.840
%
 
9.250
%
 
13.040
%
 
8.625
%
Tier 2 capital, or secondary capital, includes only the ALLL. The percentage for the secondary capital under the required column is the maximum amount allowed from all sources.
The FRB and FDIC also prescribe minimum capital requirements for Isabella Bank. At September 30, 2017, the Bank exceeded these minimum capital requirements.
Contractual Obligations and Loan Commitments
We are party to credit related financial instruments with off-balance-sheet risk. These financial instruments are entered into in the normal course of business to meet the financing needs of our customers. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of these instruments reflect the extent of involvement we have in a particular class of financial instrument.
The following table summarizes our credit related financial instruments with off-balance-sheet risk as of:

September 30
2017
 
December 31
2016
Unfunded commitments under lines of credit
$
165,768

 
$
168,840

Commitments to grant loans
43,353

 
29,339

Commercial and standby letters of credit
1,622

 
1,223

Total
$
210,743

 
$
199,402

Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. These commitments may expire without being drawn upon and do not necessarily represent future cash requirements. Advances to mortgage brokers are also included in unfunded commitments under lines of credit. The unfunded commitment amount is the difference between our outstanding balances and the maximum outstanding aggregate amount.
Commitments to grant loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The amount of collateral obtained, if it is deemed necessary, is based on management’s credit evaluation of the customer. Commitments to grant loans include residential mortgage loans with the majority being loans committed to be sold to the secondary market.
Commercial and standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements, including commercial paper, bond financing, and similar transactions. These commitments to extend credit and letters of credit generally mature within one year. The credit risk involved in these transactions is essentially the same as that involved in extending loans to customers. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon the extension of credit, is based on a credit evaluation of the borrower. While we consider standby letters of credit to be guarantees, the amount of the liability related to such guarantees on the commitment date is not significant and a liability related to such guarantees is not recorded on the consolidated balance sheets.

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Table of Contents

Our exposure to credit-related loss in the event of nonperformance by the counter parties to the financial instruments for commitments to extend credit and standby letters of credit could be up to the contractual notional amount of those instruments. We use the same credit policies as we do for extending loans to customers. No significant losses are anticipated as a result of these commitments.
Fair Value
We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. AFS securities, cash flow hedge derivative instruments and certain liabilities are recorded at fair value on a recurring basis. Additionally, from time-to-time, we may be required to record at fair value other assets on a nonrecurring basis, such as mortgage loans AFS, impaired loans, goodwill, foreclosed assets, OMSR, and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets.
For further information regarding fair value measurements see “Note 11 – Fair Value” of our notes to the interim condensed consolidated financial statements.
Liquidity
Liquidity is monitored regularly by our Market Risk Committee, which consists of members of senior management. The committee reviews projected cash flows, key ratios, and liquidity available from both primary and secondary sources.
Our primary sources of liquidity are cash and cash equivalents and unencumbered AFS securities. These categories totaled $269,687 or 15.05% of assets as of September 30, 2017, compared to $307,112 or 17.73% as of December 31, 2016. The decrease in primary liquidity is a direct result of our unencumbered AFS securities activity during 2017. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Liquidity varies significantly daily, based on customer activity.
Our primary source of funds is through deposit accounts. We also have the ability to borrow from the FHLB, the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As of September 30, 2017, we had available lines of credit of $114,839.
The following table summarizes our sources and uses of cash for the nine month period ended September 30:

2017
 
2016
 
$ Variance
Net cash provided by (used in) operating activities
$
13,728

 
$
15,565

 
$
(1,837
)
Net cash provided by (used in) investing activities
(60,627
)
 
(37,704
)
 
(22,923
)
Net cash provided by (used in) financing activities
45,072

 
21,905

 
23,167

Increase (decrease) in cash and cash equivalents
(1,827
)
 
(234
)
 
(1,593
)
Cash and cash equivalents January 1
22,894

 
21,569

 
1,325

Cash and cash equivalents September 30
$
21,067

 
$
21,335

 
$
(268
)
Market Risk
Our primary market risks are interest rate risk and liquidity risk. We have no significant foreign exchange risk in the management of IRR. Any changes in foreign exchange rates or commodity prices would have an insignificant impact on our interest income and cash flows.
IRR is the exposure of our net interest income to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. IRR is the fundamental method by which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to our earnings and capital.
The FRB has adopted a policy requiring us to effectively manage the various risks that can have a material impact on our safety and soundness. The risks include credit, interest rate, liquidity, operational, and reputational. We have policies, procedures, and internal controls for measuring and managing these risks. Specifically, our Funds Management policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long

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term assets, limiting the mismatch in repricing opportunity of assets and liabilities, and the frequency of measuring and reporting to our Board.
The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield curves, interest rate relationships, loan prepayments, and changes in funding sources. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies.
Our interest rate sensitivity is estimated by first forecasting the next 12 and 24 months of net interest income under an assumed environment of a constant balance sheet and constant market interest rates (base case). We then compare the results of various simulation analyses to the base case. At September 30, 2017, we projected the change in net interest income during the next 12 and 24 months assuming market interest rates were to immediately decrease by 100 basis points and increase by 100, 200, 300, and 400 basis points in a parallel fashion over the entire yield curve during the same time period. We did not project scenarios showing decreases in interest rates beyond 100 basis points as this is considered extremely unlikely given current interest rate levels. These projections were based on our assets and liabilities remaining static over the next 12 and 24 months, while factoring in probable calls and prepayments of certain investment securities and residential real estate and consumer loans. While it is extremely unlikely that interest rates would immediately increase to these levels, we feel that these extreme scenarios help us identify potential gaps and mismatches in the repricing characteristics of assets and liabilities. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits. As of September 30, 2017, our interest rate sensitivity results were within Board approved limits.
The following tables summarize our interest rate sensitivity for the next 12 and 24 months as of:

September 30, 2017

12 Months

24 Months
Immediate basis point change assumption (short-term)
-100
 
+100
 
+200
 
+300
 
+400
 
-100
 
+100
 
+200
 
+300
 
+400
Percent change in net interest income vs. constant rates
(1.48
)%
 
1.90
%
 
3.67
%
 
5.28
%
 
7.15
%
 
(1.57
)%
 
2.37
%
 
4.35
%
 
5.85
%
 
7.12
%
 
December 31, 2016
 
12 Months
 
24 Months
Immediate basis point change assumption (short-term)
-100
 
+100
 
+200
 
+300
 
+400
 
-100
 
+100
 
+200
 
+300
 
+400
Percent change in net interest income vs. constant rates
(4.49
)%
 
2.19
%
 
4.31
%
 
5.68
%
 
6.67
%
 
(5.32
)%
 
2.64
%
 
5.01
%
 
6.33
%
 
6.75
%

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The following tables provide information about assets and liabilities that are sensitive to changes in interest rates as of September 30, 2017 and December 31, 2016. The principal amounts of investments, loans, other interest earning assets, borrowings, and time deposits maturing were calculated based on the contractual maturity dates. Estimated cash flows for savings and NOW accounts are based on our estimated deposit decay rates.

September 30, 2017
 
2018
 
2019
 
2020
 
2021
 
2022
 
Thereafter
 
Total
 
Fair Value
Rate sensitive assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest bearing assets
$
317

 
$

 
$
100

 
$

 
$

 
$

 
$
417

 
$
413

Average interest rates
0.13
%
 
%
 
0.35
%
 
%
 
%
 
%
 
0.19
%
 
 
AFS securities
$
97,221

 
$
76,245

 
$
75,047

 
$
64,571

 
$
57,336

 
$
182,505

 
$
552,925

 
$
552,925

Average interest rates
2.31
%
 
2.43
%
 
2.56
%
 
2.57
%
 
2.37
%
 
2.51
%
 
2.46
%
 
 
Fixed interest rate loans (1)
$
165,818

 
$
115,736

 
$
111,844

 
$
128,218

 
$
118,105

 
$
210,925

 
$
850,646

 
$
830,014

Average interest rates
4.04
%
 
4.33
%
 
4.25
%
 
4.19
%
 
4.25
%
 
4.03
%
 
4.16
%
 
 
Variable interest rate loans (1)
$
74,253

 
$
34,336

 
$
23,884

 
$
21,932

 
$
25,710

 
$
46,783

 
$
226,898

 
$
226,898

Average interest rates
5.07
%
 
4.60
%
 
4.81
%
 
4.20
%
 
4.28
%
 
3.88
%
 
4.55
%
 
 
Rate sensitive liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate borrowed funds
$
137,027

 
$
95,000

 
$
20,000

 
$
35,000

 
$
50,000

 
$
20,000

 
$
357,027

 
$
357,873

Average interest rates
1.08
%
 
1.82
%
 
1.85
%
 
1.78
%
 
1.97
%
 
2.54
%
 
1.60
%
 
 
Variable rate borrowed funds
$

 
$

 
$

 
$
10,000

 
$

 
$

 
$
10,000

 
$
10,000

Average interest rates
%
 
%
 
%
 
1.61
%
 
%
 
%
 
1.61
%
 
 
Savings and NOW accounts
$
147,447

 
$
42,087

 
$
37,635

 
$
33,677

 
$
30,159

 
$
287,954

 
$
578,959

 
$
578,959

Average interest rates
0.49
%
 
0.21
%
 
0.21
%
 
0.20
%
 
0.20
%
 
0.18
%
 
0.26
%
 
 
Fixed interest rate certificates of deposit
$
201,000

 
$
73,091

 
$
35,115

 
$
49,089

 
$
39,561

 
$
21,022

 
$
418,878

 
$
417,919

Average interest rates
0.96
%
 
1.25
%
 
1.58
%
 
1.70
%
 
1.81
%
 
2.02
%
 
1.28
%
 
 
Variable interest rate certificates of deposit
$
2,346

 
$
3,269

 
$
2

 
$

 
$

 
$

 
$
5,617

 
$
5,617

Average interest rates
1.07
%
 
1.26
%
 
%
 
%
 
%
 
%
 
1.18
%
 
 

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December 31, 2016
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
 
Total
 
Fair Value
Rate sensitive assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest bearing assets
$
2,727

 
$

 
$

 
$

 
$

 
$

 
$
2,727

 
$
2,727

Average interest rates
0.34
%
 
%
 
%
 
%
 
%
 
%
 
0.34
%
 
 
AFS securities
$
114,247

 
$
71,220

 
$
64,931

 
$
63,150

 
$
66,976

 
$
177,572

 
$
558,096

 
$
558,096

Average interest rates
2.35
%
 
2.38
%
 
2.45
%
 
2.64
%
 
2.57
%
 
2.50
%
 
2.47
%
 
 
Fixed interest rate loans (1)
$
159,964

 
$
115,741

 
$
103,514

 
$
107,185

 
$
112,811

 
$
199,160

 
$
798,375

 
$
778,769

Average interest rates
4.15
%
 
4.25
%
 
4.34
%
 
4.16
%
 
4.15
%
 
4.10
%
 
4.18
%
 
 
Variable interest rate loans (1)
$
69,024

 
$
29,179

 
$
38,248

 
$
16,179

 
$
23,632

 
$
35,978

 
$
212,240

 
$
212,240

Average interest rates
4.83
%
 
4.32
%
 
4.16
%
 
3.62
%
 
3.74
%
 
3.86
%
 
4.26
%
 
 
Rate sensitive liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate borrowed funds
$
137,694

 
$
50,000

 
$
60,000

 
$
10,000

 
$
50,000

 
$
20,000

 
$
327,694

 
$
326,975

Average interest rates
0.83
%
 
2.16
%
 
1.99
%
 
1.98
%
 
1.91
%
 
2.54
%
 
1.55
%
 
 
Variable rate borrowed funds
$

 
$

 
$

 
$

 
$
10,000

 
$

 
$
10,000

 
$
10,000

Average interest rates
%
 
%
 
%
 
%
 
1.21
%
 
%
 
1.21
%
 
 
Savings and NOW accounts
$
84,972

 
$
42,596

 
$
38,220

 
$
34,326

 
$
30,858

 
$
325,583

 
$
556,555

 
$
556,555

Average interest rates
0.57
%
 
0.12
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.18
%
 
 
Fixed interest rate certificates of deposit
$
195,389

 
$
80,139

 
$
45,110

 
$
33,929

 
$
50,978

 
$
24,881

 
$
430,426

 
$
427,100

Average interest rates
0.86
%
 
1.18
%
 
1.35
%
 
1.58
%
 
1.68
%
 
1.84
%
 
1.18
%
 
 
Variable interest rate certificates of deposit
$
1,078

 
$
1,910

 
$

 
$

 
$

 
$

 
$
2,988

 
$
2,988

Average interest rates
0.62
%
 
0.99
%
 
%
 
%
 
%
 
%
 
0.85
%
 
 
 (1) The fair value reported is exclusive of the allocation of the ALLL.
We do not believe that there has been a material change in the nature or categories of our primary market risk exposure, or the particular markets that present the primary risk of loss. As of the date of this report, we do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term and we do not expect to make material changes in those methods used to measure and assess market risk in the near term. We may change those methods in the future to adapt to changes in circumstances or to implement new techniques.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
The information presented in the section captioned “Market Risk” in Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.
Item 4. Controls and Procedures.
DISCLOSURE CONTROLS AND PROCEDURES
We carried out an evaluation, under the supervision and with the participation of the Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15(d)-15(e) under the Exchange Act) as of September 30, 2017, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as of September 30, 2017, were effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the most recent fiscal quarter, no change occurred in our internal control over financial reporting that materially affected, or is likely to materially affect, our internal control over financial reporting.


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PART II – OTHER INFORMATION
Item 1. Legal Proceedings.
We are not involved in any material legal proceedings. We are involved in ordinary, routine litigation incidental to our business; however, no such routine proceedings are expected to result in any material adverse effect on operations, earnings, financial condition, or cash flows.
Item 1A. Risk Factors.
There have been no material changes to the risk factors disclosed in Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2016.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(A)
None
(B)
None
(C)
Repurchases of Common Stock
We have adopted and publicly announced a common stock repurchase plan. The plan was last amended on December 21, 2016, to allow for the repurchase of an additional 200,000 shares of common stock after that date. These authorizations do not have expiration dates. As common shares are repurchased under this plan, they are retired and revert back to the status of authorized, but unissued common shares.
The following table provides information for the three month period ended September 30, 2017, with respect to this plan:
 
Common Shares Repurchased
 
Total Number of Common Shares Purchased as Part of Publicly Announced Plan or Program
 
Maximum Number of Common Shares That May Yet Be Purchased Under the Plans or Programs

Number
 
Average Price
Per Common Share
 
 
Balance, June 30
 
 
 
 
 
 
105,875

July 1 -31
10,431

 
$
27.99

 
10,431

 
95,444

August 1 - 31
31,647

 
28.19

 
31,647

 
63,797

September 1 - 30
6,958

 
28.60

 
6,958

 
56,839

Balance, September 30
49,036

 
$
28.20

 
49,036

 
56,839

Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Not applicable.

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Item 6. Exhibits.
(a) Exhibits
Exhibit Number
 
Exhibits
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101.1*
 
101.INS (XBRL Instance Document)
 
 
 
 
 
101.SCH (XBRL Taxonomy Extension Schema Document)
 
 
 
 
 
101.CAL (XBRL Calculation Linkbase Document)
 
 
 
 
 
101.LAB (XBRL Taxonomy Label Linkbase Document)
 
 
 
 
 
101.DEF (XBRL Taxonomy Linkbase Document)
 
 
 
 
 
101.PRE (XBRL Taxonomy Presentation Linkbase Document)
*
In accordance with Rule 406T of Regulations S-T, the XBRL related information shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Isabella Bank Corporation
 
 
 
 
Date:
November 3, 2017
 
 
/s/ Jae A. Evans
 
 
 
 
Jae A. Evans
 
 
 
 
President, Chief Executive Officer
 
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
November 3, 2017
 
 
/s/ Rhonda S. Tudor
 
 
 
 
Rhonda S. Tudor
 
 
 
 
Interim Chief Financial Officer
 
 
 
 
(Principal Accounting Officer)

67