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 March 31, 2018
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 7,897,660 as of May 1, 2018.


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.
 
 
 
 
 
 
 
 
 
 

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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
CECL: Current Expected Credit Losses
 
N/A: Not applicable
CFPB: Consumer Financial Protection Bureau
 
N/M: Not meaningful
CIK: Central Index Key
 
NASDAQ: NASDAQ Stock Market Index
CRA: Community Reinvestment Act
 
NASDAQ Banks: NASDAQ Bank Stock Index
DIF: Deposit Insurance Fund
 
NAV: Net asset value
DIFS: Department of Insurance and Financial Services
 
NOW: Negotiable order of withdrawal
Directors Plan: Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors
 
NSF: Non-sufficient funds
Dividend Reinvestment Plan: Isabella Bank Corporation Stockholder Dividend Reinvestment Plan and Employee Stock Purchase Plan
 
OCI: Other comprehensive income (loss)
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
 
OMSR: Originated mortgage servicing rights
ESOP: Employee Stock Ownership Plan
 
OREO: Other real estate owned
Exchange Act: Securities Exchange Act of 1934
 
OTTI: Other-than-temporary impairment
FASB: Financial Accounting Standards Board
 
PBO: Projected benefit obligation
FDI Act: Federal Deposit Insurance Act
 
PCAOB: Public Company Accounting Oversight Board
FDIC: Federal Deposit Insurance Corporation
 
Rabbi Trust: A trust established to fund the Directors Plan
FFIEC: Federal Financial Institutions Examinations Council
 
SEC: U.S. Securities and Exchange Commission
FRB: Federal Reserve Bank
 
SOX: Sarbanes-Oxley Act of 2002
FHLB: Federal Home Loan Bank
 
Tax Act: Tax Cuts and Jobs Act, enacted December 22, 2017
Freddie Mac: Federal Home Loan Mortgage Corporation
 
TDR: Troubled debt restructuring
FTE: Fully taxable equivalent
 
XBRL: eXtensible Business Reporting Language

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Table of Contents

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

March 31
2018
 
December 31
2017
ASSETS
 
 
 
Cash and cash equivalents
 
 
 
Cash and demand deposits due from banks
$
15,739

 
$
25,267

Interest bearing balances due from banks
973

 
5,581

Total cash and cash equivalents
16,712

 
30,848

AFS securities, at fair value
547,762

 
548,730

Equity securities, at fair value
3,575

 
3,577

Mortgage loans AFS
359

 
1,560

Loans
 
 
 
Commercial
643,636

 
634,759

Agricultural
122,330

 
128,269

Residential real estate
270,150

 
272,368

Consumer
56,886

 
56,123

Gross loans
1,093,002

 
1,091,519

Less allowance for loan and lease losses
8,200

 
7,700

Net loans
1,084,802

 
1,083,819

Premises and equipment
28,493

 
28,450

Corporate owned life insurance policies
27,196

 
27,026

Accrued interest receivable
7,134

 
7,063

Equity securities without readily determinable fair values
23,391

 
23,454

Goodwill and other intangible assets
48,522

 
48,547

Other assets
11,646

 
10,056

TOTAL ASSETS
$
1,799,592

 
$
1,813,130

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits
 
 
 
Noninterest bearing
$
223,798

 
$
237,511

NOW accounts
235,965

 
231,666

Certificates of deposit under $250 and other savings
765,325

 
728,090

Certificates of deposit over $250
72,780

 
67,991

Total deposits
1,297,868

 
1,265,258

Borrowed funds
303,113

 
344,878

Accrued interest payable and other liabilities
7,521

 
8,089

Total liabilities
1,608,502

 
1,618,225

Shareholders’ equity
 
 
 
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,894,341 shares (including 27,705 shares held in the Rabbi Trust) in 2018 and 7,857,293 shares (including 31,769 shares held in the Rabbi Trust) in 2017
141,318

 
140,277

Shares to be issued for deferred compensation obligations
5,502

 
5,502

Retained earnings
52,926

 
51,728

Accumulated other comprehensive income (loss)
(8,656
)
 
(2,602
)
Total shareholders’ equity
191,090

 
194,905

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,799,592

 
$
1,813,130



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 
 March 31
 
2018
 
2017
Interest income
 
 
 
Loans, including fees
$
11,296

 
$
10,120

AFS securities
 
 
 
Taxable
2,122

 
2,113

Nontaxable
1,382

 
1,415

Federal funds sold and other
321

 
213

Total interest income
15,121

 
13,861

Interest expense
 
 
 
Deposits
2,046

 
1,540

Borrowings
1,355

 
1,291

Total interest expense
3,401

 
2,831

Net interest income
11,720

 
11,030

Provision for loan losses
384

 
27

Net interest income after provision for loan losses
11,336

 
11,003

Noninterest income
 
 
 
Service charges and fees
1,488

 
1,530

Net gain on sale of mortgage loans
81

 
155

Earnings on corporate owned life insurance policies
170

 
180

Other
748

 
751

Total noninterest income
2,487

 
2,616

Noninterest expenses
 
 
 
Compensation and benefits
5,494

 
5,557

Furniture and equipment
1,479

 
1,344

Occupancy
824

 
837

Other
2,299

 
2,213

Total noninterest expenses
10,096

 
9,951

Income before federal income tax expense
3,727

 
3,668

Federal income tax expense
265

 
532

NET INCOME
$
3,462

 
$
3,136

Earnings per common share
 
 
 
Basic
$
0.44

 
$
0.40

Diluted
$
0.43

 
$
0.39

Cash dividends per common share
$
0.26

 
$
0.25










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

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Table of Contents

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

Three Months Ended 
 March 31
 
2018
 
2017
Net income
$
3,462

 
$
3,136

Unrealized gains (losses) on AFS securities arising during the period
(8,057
)
 
1,677

Tax effect (1)
1,684

 
(450
)
Unrealized gains (losses) on AFS securities, net of tax
(6,373
)
 
1,227

Unrealized gains (losses) on derivative instruments arising during the period
122

 
17

Tax effect (1)
(26
)
 
(6
)
Unrealized gains (losses) on derivative instruments, net of tax
96

 
11

Other comprehensive income (loss), net of tax
(6,277
)
 
1,238

Comprehensive income
$
(2,815
)
 
$
4,374

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























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

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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, 2017
7,821,069

 
$
139,525

 
$
5,038

 
$
46,114

 
$
(2,778
)
 
$
187,899

Comprehensive income (loss)

 

 

 
3,136

 
1,238

 
4,374

Issuance of common stock
63,866

 
1,770

 

 

 

 
1,770

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

 
168

 
(168
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
178

 

 

 
178

Common stock purchased for deferred compensation obligations

 
(123
)
 

 

 

 
(123
)
Common stock repurchased pursuant to publicly announced repurchase plan
(41,815
)
 
(1,169
)
 

 

 

 
(1,169
)
Cash dividends paid ($0.25 per common share)

 

 

 
(1,953
)
 

 
(1,953
)
Balance, March 31, 2017
7,843,120

 
$
140,171

 
$
5,048

 
$
47,297

 
$
(1,540
)
 
$
190,976

Balance, January 1, 2018
7,857,293

 
$
140,277

 
$
5,502

 
$
51,728

 
$
(2,602
)
 
$
194,905

Comprehensive income (loss)

 

 

 
3,462

 
(6,277
)
 
(2,815
)
Adoption of ASU 2016-01

 

 

 
(223
)
 
223

 

Issuance of common stock
59,560

 
1,616

 

 

 

 
1,616

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

 
146

 
(146
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
146

 

 

 
146

Common stock purchased for deferred compensation obligations

 
(101
)
 

 

 

 
(101
)
Common stock repurchased pursuant to publicly announced repurchase plan
(22,512
)
 
(620
)
 

 

 

 
(620
)
Cash dividends paid ($0.26 per common share)

 

 

 
(2,041
)
 

 
(2,041
)
Balance, March 31, 2018
7,894,341

 
$
141,318

 
$
5,502

 
$
52,926

 
$
(8,656
)
 
$
191,090














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

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

Three Months Ended 
 March 31
 
2018
 
2017
OPERATING ACTIVITIES
 
 
 
Net income
$
3,462

 
$
3,136

Reconciliation of net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
384

 
27

Impairment of foreclosed assets

 
28

Depreciation
717

 
722

Amortization of OMSR
67

 
81

Amortization of acquisition intangibles
25

 
31

Net amortization of AFS securities
491

 
530

Net unrealized (gains) losses on equity securities, at fair value
2

 

Net gain on sale of mortgage loans
(81
)
 
(155
)
Increase in cash value of corporate owned life insurance policies
(170
)
 
(180
)
Share-based payment awards under equity compensation plan
146

 
178

Origination of loans held-for-sale
(3,843
)
 
(8,432
)
Proceeds from loan sales
5,125

 
8,635

Net changes in operating assets and liabilities which provided (used) cash:
 
 
 
Accrued interest receivable
(71
)
 
(466
)
Other assets
124

 
322

Accrued interest payable and other liabilities
(568
)
 
(70
)
Net cash provided by (used in) operating activities
5,810

 
4,387

INVESTING ACTIVITIES
 
 
 
Activity in AFS securities
 
 
 
Maturities, calls, and principal payments
14,262

 
19,413

Purchases
(21,842
)
 
(50,284
)
Net loan principal (originations) collections
(1,375
)
 
(2,258
)
Proceeds from sales of foreclosed assets
70

 
71

Purchases of premises and equipment
(760
)
 
(390
)
Net cash provided by (used in) investing activities
(9,645
)
 
(33,448
)

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Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
 
Three Months Ended 
 March 31
 
2018
 
2017
FINANCING ACTIVITIES
 
 
 
Net increase (decrease) in deposits
32,610

 
36,021

Net increase (decrease) in borrowed funds
(41,765
)
 
(10,319
)
Cash dividends paid on common stock
(2,041
)
 
(1,953
)
Proceeds from issuance of common stock
1,616

 
1,770

Common stock repurchased
(620
)
 
(1,169
)
Common stock purchased for deferred compensation obligations
(101
)
 
(123
)
Net cash provided by (used in) financing activities
(10,301
)
 
24,227

Increase (decrease) in cash and cash equivalents
(14,136
)
 
(4,834
)
Cash and cash equivalents at beginning of period
30,848

 
22,894

Cash and cash equivalents at end of period
$
16,712

 
$
18,060

SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Interest paid
$
3,405

 
$
2,823

Income taxes paid
$

 
$

SUPPLEMENTAL NONCASH INFORMATION:
 
 
 
Transfers of loans to foreclosed assets
$
8

 
$
26




















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” refers 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 month period ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2017.
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, 2017.
Reclassifications: Certain amounts reported in the interim 2017 consolidated financial statements have been reclassified to conform with the 2018 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 
 March 31

2018
 
2017
Average number of common shares outstanding for basic calculation
7,873,948

 
7,827,143

Average potential effect of common shares in the Directors Plan (1)
199,270

 
191,533

Average number of common shares outstanding used to calculate diluted earnings per common share
8,073,218

 
8,018,676

Net income
$
3,462

 
$
3,136

Earnings per common share
 
 
 
Basic
$
0.44

 
$
0.40

Diluted
$
0.43

 
$
0.39

(1) 
Exclusive of shares held in the Rabbi Trust
Note 3 – Accounting Standards Updates
Recently Adopted 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 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.
The new authoritative guidance, as amended, was effective on January 1, 2018. We reviewed our contracts related to trust and investment services and those related to other noninterest income to determine if changes in income recognition were required

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as a result of this guidance. Implementation of this guidance did not have a significant impact on our operating results for the three month period ended March 31, 2018.
ASU No. 2016-01: “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Liabilities”
In January 2016, ASU No. 2016-01 set forth the following: 1) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income; 2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment and requiring measurement of the investment at fair value when an impairment exists; 3) for public entities, eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; 4) for public entities, requires the use of exit price notion when measuring the fair value of financial instruments for disclosure purposes; 5) requires an entity to present separately in other comprehensive income, the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; 6) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; and 7) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets.
The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2017. As a result of this guidance, the change in the fair value of equity investments has been recorded in net income beginning on January 1, 2018. Equity securities are now recorded separately from AFS securities and are recorded at a fair value which approximates an exit price notion. Adoption of this guidance had an insignificant impact on our operations and its future impact will depend on the fair value of these investments at the future measurement dates. The disclosures related to equity investment securities reflect a fully retrospective presentation for comparative purposes.
For discussion of the fair value measurement of financial instruments, refer to “Note 11 – Fair Value”.
In February 2018, ASU No. 2018-03: “Technical Corrections and Improvements to Financial Instruments - Overall (Subtopic 825-10: Recognition and Measurement of Financial Assets and Financial Liabilities” was issued. This update sets forth correction or improvement amendments for specific issues that may arise within the scope of ASU 2016-01. These amendments follow ASU 2016-01 with regard to effective dates.
ASU No. 2017-09: Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting”
In May 2017, ASU No. 2017-09 was issued and 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 did not have a significant impact on our operating results or financial statement disclosures.
Pending Accounting Standards Updates
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

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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. 2016-13: “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”
In June 2016, ASU No. 2016-13 updated the measurement for credit losses for AFS debt securities and assets measured at amortized cost which include loans, trade receivables, and any other financial assets with the contractual right to receive cash. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. Under the incurred loss approach, entities are limited to a probable initial recognition threshold when credit losses are measured under GAAP; an entity generally only considers past events and current conditions in measuring the incurred loss.
Under the new guidance, the incurred loss impairment methodology in current GAAP is replaced with a methodology that reflects current expected credit losses (CECL). This methodology requires consideration of a broader range of reasonable and supportable information to calculate credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances which applies to assets measured either collectively or individually.
The update allows an entity to revert to historical loss information that is reflective of the contractual term (considering the effect of prepayments) for periods that are beyond the time frame for which the entity is able to develop reasonable and supportable forecasts. In addition, the disclosures of credit quality indicators in relation to the amortized cost of financing receivables, a current disclosure requirement, are further disaggregated by year of origination (or vintage). The vintage information will be useful for financial statement users to better assess changes in underwriting standards and credit quality trends in asset portfolios over time and the effect of those changes on credit losses.
Overall, the update will allow entities the ability to measure expected credit losses without the restriction of incurred or probable losses that exist under current GAAP. For users of the financial statements, the update provides decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2019 and may have a significant impact on our operations and financial statement disclosures as well as that of the banking industry as a whole.
We have invested a considerable amount of effort toward this guidance and will continue to invest considerable effort until its effective date. A committee was formed and has developed a road map to implementation. This committee will monitor progress to ensure timely and accurate adoption of the guidance. We are working to identify and collect required borrower and loan level data. We recognize that quality data is key to properly identify loan segments and then apply the most appropriate methodology to each segment. We anticipate a significant amount of progress during 2018 to position ourselves to be able to run parallel models during 2019. This will allow us to solidify our methodology for implementation in 2020.

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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:
 
March 31, 2018

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
205

 
$

 
$
3

 
$
202

States and political subdivisions
209,788

 
2,240

 
395

 
211,633

Auction rate money market preferred
3,200

 

 
188

 
3,012

Mortgage-backed securities
212,713

 
103

 
5,955

 
206,861

Collateralized mortgage obligations
129,095

 
73

 
3,114

 
126,054

Total
$
555,001

 
$
2,416

 
$
9,655

 
$
547,762

 
December 31, 2017

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
217

 
$

 
$
1

 
$
216

States and political subdivisions
204,131

 
4,486

 
143

 
208,474

Auction rate money market preferred
3,200

 

 
151

 
3,049

Mortgage-backed securities
210,757

 
390

 
2,350

 
208,797

Collateralized mortgage obligations
129,607

 
160

 
1,573

 
128,194

Total
$
547,912

 
$
5,036

 
$
4,218

 
$
548,730

The amortized cost and fair value of AFS securities by contractual maturity at March 31, 2018 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
$

 
$
205

 
$

 
$

 
$

 
$
205

States and political subdivisions
24,933

 
79,352

 
71,772

 
33,731

 

 
209,788

Auction rate money market preferred

 

 

 

 
3,200

 
3,200

Mortgage-backed securities

 

 

 

 
212,713

 
212,713

Collateralized mortgage obligations

 

 

 

 
129,095

 
129,095

Total amortized cost
$
24,933

 
$
79,557

 
$
71,772

 
$
33,731

 
$
345,008

 
$
555,001

Fair value
$
24,968

 
$
80,351

 
$
72,692

 
$
33,824

 
$
335,927

 
$
547,762

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 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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The following information pertains to AFS securities with gross unrealized losses at March 31, 2018 and December 31, 2017, aggregated by investment category and length of time that individual securities have been in a continuous loss position.
 
March 31, 2018
 
Less Than Twelve Months
 
Twelve Months or More
 
 

Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total
Unrealized
Losses
Government sponsored enterprises
$
3

 
$
202

 
$

 
$

 
$
3

States and political subdivisions
395

 
32,838

 

 
150

 
395

Auction rate money market preferred

 

 
188

 
3,012

 
188

Mortgage-backed securities
2,756

 
121,210

 
3,199

 
71,928

 
5,955

Collateralized mortgage obligations
1,998

 
96,415

 
1,116

 
23,922

 
3,114

Total
$
5,152

 
$
250,665

 
$
4,503

 
$
99,012

 
$
9,655

Number of securities in an unrealized loss position:
 
 
151

 
 
 
24

 
175

 
December 31, 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
$
1

 
$
216

 
$

 
$

 
$
1

States and political subdivisions
142

 
16,139

 
1

 
188

 
143

Auction rate money market preferred

 

 
151

 
3,049

 
151

Mortgage-backed securities
454

 
72,007

 
1,896

 
76,065

 
2,350

Collateralized mortgage obligations
701

 
76,435

 
872

 
25,308

 
1,573

Total
$
1,298

 
$
164,797

 
$
2,920

 
$
104,610

 
$
4,218

Number of securities in an unrealized loss position:
 
 
81

 
 
 
24

 
105

As of March 31, 2018 and December 31, 2017, 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
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 reduced the carrying value to $230 which required us to recognized an OTTI of $770 in earnings for the year ended December 31, 2016. Based on internal analysis of this bond as of March 31, 2018, there was no additional OTTI recognized as of March 31, 2018 and the carrying value of this bond remained at $230.

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The following table provides a roll-forward of credit related impairment recorded in earnings for the:

Three Months Ended 
 March 31
 
2018
 
2017
Balance at beginning of the period
$
770

 
$
770

Additions to credit losses for which no previous OTTI was recognized

 

Reductions for credit losses realized on securities sold during the period

 

Balance at end of the period
$
770

 
$
770

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 March 31, 2018 or December 31, 2017, 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. Some 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 pay off 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

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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.
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 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 15 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.

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A summary of changes in the ALLL and the recorded investment in loans by segments follows:
 
Allowance for Loan Losses

Three Months Ended March 31, 2018

Commercial

Agricultural

Residential Real Estate

Consumer

Unallocated

Total
January 1, 2018
$
1,706


$
611


$
2,563


$
900


$
1,920


$
7,700

Charge-offs
(5
)



(10
)

(88
)



(103
)
Recoveries
103




56


60




219

Provision for loan losses
36


613


(127
)

(77
)

(61
)

384

March 31, 2018
$
1,840


$
1,224


$
2,482


$
795


$
1,859


$
8,200

 
Allowance for Loan Losses and Recorded Investment in Loans
 
March 31, 2018

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
842

 
$
141

 
$
1,520

 
$

 
$

 
$
2,503

Collectively evaluated for impairment
998

 
1,083

 
962

 
795

 
1,859

 
5,697

Total
$
1,840

 
$
1,224

 
$
2,482

 
$
795

 
$
1,859

 
$
8,200

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
11,675

 
$
11,468

 
$
7,940

 
$
12

 
 
 
$
31,095

Collectively evaluated for impairment
631,961

 
110,862

 
262,210

 
56,874

 
 
 
1,061,907

Total
$
643,636

 
$
122,330

 
$
270,150

 
$
56,886

 
 
 
$
1,093,002

 
Allowance for Loan Losses
 
Three Months Ended March 31, 2017

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
January 1, 2017
$
1,814

 
$
884

 
$
2,664

 
$
624

 
$
1,414

 
$
7,400

Charge-offs
(27
)
 

 
(43
)
 
(74
)
 

 
(144
)
Recoveries
133

 

 
36

 
48

 

 
217

Provision for loan losses
(149
)
 
(357
)
 
441

 
73

 
19

 
27

March 31, 2017
$
1,771

 
$
527

 
$
3,098

 
$
671

 
$
1,433

 
$
7,500

 
Allowance for Loan Losses and Recorded Investment in Loans
 
December 31, 2017

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
650

 
$

 
$
1,480

 
$

 
$

 
$
2,130

Collectively evaluated for impairment
1,056

 
611

 
1,083

 
900

 
1,920

 
5,570

Total
$
1,706

 
$
611

 
$
2,563

 
$
900

 
$
1,920

 
$
7,700

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
8,099

 
$
10,598

 
$
7,939

 
$
17

 
 
 
$
26,653

Collectively evaluated for impairment
626,660

 
117,671

 
264,429

 
56,106

 
 
 
1,064,866

Total
$
634,759


$
128,269

 
$
272,368

 
$
56,123

 
 
 
$
1,091,519


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The following table displays the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit risk ratings as of:
 
March 31, 2018
 
Commercial
 
Agricultural
 
 

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

 
 
1 - Excellent
$
23

 
$

 
$

 
$
23

 
$

 
$
34

 
$
34

 
$
57

2 - High quality
5,417

 
14,939

 

 
20,356

 
2,783

 
814

 
3,597

 
23,953

3 - High satisfactory
117,378

 
44,538

 
17,974

 
179,890

 
20,474

 
6,094

 
26,568

 
206,458

4 - Low satisfactory
337,859

 
84,149

 

 
422,008

 
46,040

 
18,066

 
64,106

 
486,114

5 - Special mention
8,615

 
1,562

 

 
10,177

 
9,618

 
5,192

 
14,810

 
24,987

6 - Substandard
5,424

 
2,191

 

 
7,615

 
6,435

 
4,887

 
11,322

 
18,937

7 - Vulnerable
2,364

 
1,203

 

 
3,567

 
1,529

 
364

 
1,893

 
5,460

8 - Doubtful

 

 

 

 

 

 

 

Total
$
477,080

 
$
148,582

 
$
17,974

 
$
643,636

 
$
86,879

 
$
35,451

 
$
122,330

 
$
765,966

 
December 31, 2017
 
Commercial
 
Agricultural
 
 

Real Estate
 
Other
 
Advances to Mortgage Brokers
 
Total
 
Real Estate
 
Other
 
Total
 
Total
Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1 - Excellent
$
24

 
$
316

 
$

 
$
340

 
$

 
$
34

 
$
34

 
$
374

2 - High quality
8,402

 
12,262

 

 
20,664

 
2,909

 
1,024

 
3,933

 
24,597

3 - High satisfactory
131,826

 
46,668

 
12,081

 
190,575

 
21,072

 
8,867

 
29,939

 
220,514

4 - Low satisfactory
326,166

 
75,591

 

 
401,757

 
47,835

 
18,467

 
66,302

 
468,059

5 - Special mention
8,986

 
3,889

 

 
12,875

 
10,493

 
8,546

 
19,039

 
31,914

6 - Substandard
5,521

 
2,298

 

 
7,819

 
4,325

 
2,747

 
7,072

 
14,891

7 - Vulnerable
729

 

 

 
729

 
1,531

 
419

 
1,950

 
2,679

8 - Doubtful

 

 

 

 

 

 

 

Total
$
481,654

 
$
141,024

 
$
12,081

 
$
634,759

 
$
88,165

 
$
40,104

 
$
128,269

 
$
763,028

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.

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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.
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.

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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.
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:
 
March 31, 2018
 
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
$
95

 
$
30

 
$
51

 
$
2,364

 
$
2,540

 
$
474,540

 
$
477,080

Commercial other
1,331

 
49

 

 
1,203

 
2,583

 
145,999

 
148,582

Advances to mortgage brokers

 

 

 

 

 
17,974

 
17,974

Total commercial
1,426

 
79

 
51

 
3,567

 
5,123

 
638,513

 
643,636

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate
805

 
804

 
463

 
1,529

 
3,601

 
83,278

 
86,879

Agricultural other
250

 
42

 
18

 
364

 
674

 
34,777

 
35,451

Total agricultural
1,055

 
846

 
481

 
1,893

 
4,275

 
118,055

 
122,330

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
3,020

 
300

 
22

 
754

 
4,096

 
225,033

 
229,129

Junior liens
23

 

 
10

 
23

 
56

 
6,422

 
6,478

Home equity lines of credit
189

 
173

 
100

 

 
462

 
34,081

 
34,543

Total residential real estate
3,232

 
473

 
132

 
777

 
4,614

 
265,536

 
270,150

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
103

 

 

 

 
103

 
52,958

 
53,061

Unsecured
12

 

 

 

 
12

 
3,813

 
3,825

Total consumer
115

 

 

 

 
115

 
56,771

 
56,886

Total
$
5,828

 
$
1,398

 
$
664

 
$
6,237

 
$
14,127

 
$
1,078,875

 
$
1,093,002


20

Table of Contents

 
December 31, 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
$
295

 
$
325

 
$
54

 
$
729

 
$
1,403

 
$
480,251

 
$
481,654

Commercial other
1,069

 
28

 
18

 

 
1,115

 
139,909

 
141,024

Advances to mortgage brokers

 

 

 

 

 
12,081

 
12,081

Total commercial
1,364

 
353

 
72

 
729

 
2,518

 
632,241

 
634,759

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate
84

 
190

 

 
1,531

 
1,805

 
86,360

 
88,165

Agricultural other
39

 

 
104

 
419

 
562

 
39,542

 
40,104

Total agricultural
123

 
190

 
104

 
1,950

 
2,367

 
125,902

 
128,269

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
3,718

 
234

 
132

 
325

 
4,409

 
225,007

 
229,416

Junior liens
69

 
10

 

 
23

 
102

 
6,812

 
6,914

Home equity lines of credit
293

 

 
77

 

 
370

 
35,668

 
36,038

Total residential real estate
4,080

 
244

 
209

 
348

 
4,881

 
267,487

 
272,368

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
37

 
10

 
10

 

 
57

 
52,005

 
52,062

Unsecured
13

 

 

 

 
13

 
4,048

 
4,061

Total consumer
50

 
10

 
10

 

 
70

 
56,053

 
56,123

Total
$
5,617

 
$
797

 
$
395

 
$
3,027

 
$
9,836

 
$
1,081,683

 
$
1,091,519

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.

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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:
 
March 31, 2018
 
December 31, 2017

Recorded Balance
 
Unpaid Principal Balance
 
Valuation Allowance
 
Recorded Balance
 
Unpaid Principal Balance
 
Valuation Allowance
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
5,946

 
$
6,234

 
$
639

 
$
4,089

 
$
4,378

 
$
626

Commercial other
2,099

 
2,099

 
203

 
995

 
995

 
24

Agricultural real estate
881

 
881

 
141

 

 

 

Agricultural other

 

 

 

 

 

Residential real estate senior liens
7,831

 
8,459

 
1,514

 
7,816

 
8,459

 
1,473

Residential real estate junior liens
36

 
36

 
6

 
44

 
44

 
7

Total impaired loans with a valuation allowance
16,793

 
17,709

 
2,503

 
12,944

 
13,876

 
2,130

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
2,466

 
2,540

 
 
 
1,791

 
1,865

 
 
Commercial other
1,164

 
1,164

 
 
 
1,224

 
1,224

 
 
Agricultural real estate
8,082

 
8,082

 
 
 
7,913

 
7,913

 
 
Agricultural other
2,505

 
2,505

 
 
 
2,685

 
2,685

 
 
Home equity lines of credit
73

 
373

 
 
 
79

 
379

 
 
Consumer secured
12

 
12

 
 
 
17

 
17

 
 
Total impaired loans without a valuation allowance
14,302

 
14,676

 
 
 
13,709

 
14,083

 
 
Impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial
11,675

 
12,037

 
842

 
8,099

 
8,462

 
650

Agricultural
11,468

 
11,468

 
141

 
10,598

 
10,598

 

Residential real estate
7,940

 
8,868

 
1,520

 
7,939

 
8,882

 
1,480

Consumer
12

 
12

 

 
17

 
17

 

Total impaired loans
$
31,095

 
$
32,385

 
$
2,503

 
$
26,653

 
$
27,959

 
$
2,130












22

Table of Contents

The following is a summary of information pertaining to impaired loans for the:
 
Three Months Ended March 31
 
2018
 
2017

Average Recorded Balance
 
Interest Income Recognized
 
Average Recorded Balance
 
Interest Income Recognized
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
$
5,018

 
$
91

 
$
5,015

 
$
73

Commercial other
1,547

 
24

 
1,275

 
24

Agricultural real estate
441

 
4

 

 

Agricultural other

 

 
67

 

Residential real estate senior liens
7,824

 
74

 
8,420

 
83

Residential real estate junior liens
40

 

 
75

 

Total impaired loans with a valuation allowance
14,870

 
193


14,852


180

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
2,129

 
35

 
1,326

 
33

Commercial other
1,194

 
17

 
114

 
2

Agricultural real estate
7,998

 
40

 
4,042

 
62

Agricultural other
2,595

 
36

 
1,438

 
13

Home equity lines of credit
76

 
5

 
133

 
5

Consumer secured
15

 

 
25

 

Total impaired loans without a valuation allowance
14,007

 
133

 
7,078

 
115

Impaired loans
 
 
 
 
 
 
 
Commercial
9,888

 
167

 
7,730

 
132

Agricultural
11,034

 
80

 
5,547

 
75

Residential real estate
7,940

 
79

 
8,628

 
88

Consumer
15

 

 
25

 

Total impaired loans
$
28,877

 
$
326

 
$
21,930

 
$
295

We had committed to advance $637 and $472 in connection with impaired loans, which includes TDRs, as of March 31, 2018 and December 31, 2017, 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).

23

Table of Contents

The following is a summary of information pertaining to TDRs granted for the:
 
Three Months Ended March 31
 
2018
 
2017

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

 
$
1,255

 
$
1,255

 
2

 
$
227

 
$
227

Agricultural other
2

 
1,061

 
1,061

 

 

 

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Senior liens
2

 
167

 
167

 

 

 

Junior liens

 

 

 
1

 
8

 
8

Total residential real estate
2

 
167

 
167

 
1

 
8

 
8

Total
7

 
$
2,483

 
$
2,483

 
3

 
$
235

 
$
235

The following table summarizes concessions we granted to borrowers in financial difficulty for the:

Three Months Ended March 31

2018
 
2017

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
1

 
$
174

 
2

 
$
1,081

 

 
$

 
2

 
$
227

Agricultural other
1

 
98

 
1

 
963

 

 

 

 

Residential real estate


 


 


 


 


 


 


 


Senior liens

 

 
2

 
167

 

 

 

 

Junior liens

 

 

 

 
1

 
8

 

 

Total residential real estate

 

 
2

 
167

 
1

 
8

 

 

Total
2

 
$
272

 
5

 
$
2,211

 
1

 
$
8

 
2

 
$
227

We did not restructure any loans by forgiving principal or accrued interest in the three month periods ended March 31, 2018 or 2017.
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 month periods ended March 31, 2018 and March 31, 2017 which were modified within 12 months prior to the default date.
The following is a summary of TDR loan balances as of:
 
March 31, 2018
 
December 31, 2017
TDRs
$
27,540

 
$
26,197


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Table of Contents

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:

March 31
2018
 
December 31
2017
FHLB Stock
$
13,700

 
$
13,700

Corporate Settlement Solutions, LLC
7,358

 
7,421

FRB Stock
1,999

 
1,999

Other
334

 
334

Total
$
23,391

 
$
23,454

Note 7 – Borrowed Funds
Borrowed funds consist of the following obligations as of:
 
March 31, 2018
 
December 31, 2017

Amount
 
Rate
 
Amount
 
Rate
FHLB advances
$
260,000

 
1.94
%
 
$
290,000

 
1.94
%
Securities sold under agreements to repurchase without stated maturity dates
32,913

 
0.09
%
 
54,878

 
0.12
%
Federal funds purchased
10,200

 
1.89
%
 

 
%
Total
$
303,113

 
1.74
%
 
$
344,878

 
1.65
%
FHLB advances are collateralized by a blanket lien on all qualified 1-4 family residential real estate loans, specific AFS securities, and FHLB stock.
The following table lists the maturities and weighted average interest rates of FHLB advances as of:
 
March 31, 2018
 
December 31, 2017

Amount
 
Rate
 
Amount
 
Rate
Fixed rate due 2018
$
30,000

 
1.57
%
 
$
70,000

 
1.96
%
Fixed rate due 2019
85,000

 
1.87
%
 
85,000

 
1.87
%
Fixed rate due 2020
35,000

 
1.80
%
 
35,000

 
1.80
%
Fixed rate due 2021
50,000

 
1.91
%
 
50,000

 
1.91
%
Variable rate due 2021 1
10,000

 
2.15
%
 
10,000

 
1.72
%
Fixed rate due 2022
20,000

 
1.97
%
 
20,000

 
1.97
%
Fixed rate due 2023
20,000

 
3.36
%
 
10,000

 
3.90
%
Fixed rate due 2026
10,000

 
1.17
%
 
10,000

 
1.17
%
Total
$
260,000

 
1.94
%
 
$
290,000

 
1.94
%
(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 $32,933 and $54,898 at March 31, 2018 and December 31, 2017, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.

25

Table of Contents

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 and federal funds purchased. We had no FRB Discount Window advances during the three month periods ended March 31, 2018 or 2017.
 
Three Months Ended March 31
 
2018
 
2017

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
$
38,967

 
$
35,995

 
0.10
%
 
$
58,088

 
$
57,505

 
0.13
%
Federal funds purchased
10,200

 
4,460

 
1.66
%
 
5,200

 
863

 
0.96
%
We had pledged AFS securities and 1-4 family residential real estate loans in the following amounts at:

March 31
2018
 
December 31
2017
Pledged to secure borrowed funds
$
402,702

 
$
410,988

Pledged to secure repurchase agreements
32,933

 
54,898

Pledged for public deposits and for other purposes necessary or required by law
33,958

 
27,976

Total
$
469,593

 
$
493,862

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

March 31
2018
 
December 31
2017
States and political subdivisions
$
2,413

 
$
7,332

Mortgage-backed securities
9,192

 
13,199

Collateralized mortgage obligations
21,328

 
34,367

Total
$
32,933

 
$
54,898

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 March 31, 2018, we had the ability to borrow up to an additional $153,347, 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.

26

Table of Contents

The following tables provide information on derivatives related to variable rate borrowings as of:
 
March 31, 2018
 
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
 
3.1
 
$
10,000

 
Other Assets
 
$
413

 
December 31, 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
 
3.3
 
$
10,000

 
Other Assets
 
$
291

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 counterparty limits. We do not anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.
Note 8 – Revenue
Our revenue is comprised primarily of interest income, service charges and fees, gains on the sale of loans and AFS securities, earnings on corporate owned life insurance policies, and other noninterest income. Other noninterest income is typically service and performance driven in nature and comprised primarily of trust and brokerage advisory fees. We recognize revenue in accordance with GAAP as outlined in ASC 606, Revenue From Contracts with Customers. Revenue is recognized when our performance obligation has been satisfied according to our contractual obligation.
We record receivables when revenue is unpaid and collectability is reasonably assured. Accounts receivable balances primarily represent amounts due from customers for which revenue has been recognized. Accounts receivable balances are recorded in the consolidated balance sheets in accrued interest receivable and other assets. For the three month periods ended March 31, 2018 and 2017, we satisfied our performance obligations pursuant to contracts with customers. As a result, we have not recorded contract assets or liabilities. We estimate no returns or allowances for the three month periods ended March 31, 2018 and 2017.
Our contracts with customers define our performance obligations with clearly established pricing which did not require us to allocate or disaggregate revenue by performance obligation. A summary of revenue recognized for each major category of contracts with customers, subject to ASC 606, is as follows for the:
 
Three Months Ended 
 March 31

2018
 
2017
Debit card income
$
588

 
$
530

Trust service fees
502

 
411

Brokerage advisory fees
156

 
160

Service charges and fees related to deposit accounts
85

 
85

Total
$
1,331

 
$
1,186

A large portion of our revenue consists of interest income which is not subject to the requirements set forth in ASU 2014-09. This recently adopted guidance required us to review our other noninterest revenue sources within the scope of the guidance to ensure appropriate recognition of revenue from contracts with customers. This review process did not identify significant changes related to revenue recognition. As such, we did not record or disclose transactions related to the adoption of this guidance.

27

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 
 March 31
 
2018
 
2017
Consulting fees
$
250

 
$
205

ATM and debit card fees
232

 
216

Director fees
209

 
209

Audit and related fees
202

 
198

FDIC insurance premiums
164

 
153

Donations and community relations
151

 
130

Loan underwriting fees
149

 
117

Postage and freight
131

 
109

Education and travel
115

 
96

Marketing costs
110

 
89

All other
586

 
691

Total other
$
2,299

 
$
2,213

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 income before federal income tax expense, which has significantly changed as a result of 2017 Tax Act, is as follows for the:

Three Months Ended 
 March 31
 
2018
 
2017
Income taxes at statutory rate (21% in 2018 and 34% in 2017)
$
783

 
$
1,247

Effect of nontaxable income
 
 
 
Interest income on tax exempt municipal securities
(274
)
 
(455
)
Earnings on corporate owned life insurance policies
(36
)
 
(61
)
Effect of tax credits
(200
)
 
(189
)
Other
(11
)
 
(18
)
Total effect of nontaxable income
(521
)
 
(723
)
Effect of nondeductible expenses
3

 
8

Federal income tax expense
$
265

 
$
532


28

Table of Contents

Note 11 – Fair Value
Under fair value measurement and disclosure authoritative guidance, we group assets and liabilities measured at fair value into three levels, based on the markets in which the assets and liabilities are traded, and the reliability of the assumptions used to determine fair value, based on the prioritization of inputs in the valuation techniques. These levels are:
Level 1:
Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2:
Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model based valuation techniques for which all significant assumptions are observable in the market.
Level 3:
Valuation is generated from model based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.
The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. Transfers between measurement levels are recognized at the end of reporting periods.
Fair value measurement requires the use of an exit price notion which may differ from entrance pricing. Generally we believe our assets and liabilities classified as Level 1 or Level 2 approximate an exit price notion.
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.
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.
Equity securities, at fair value: Equity securities are recorded at fair value on a recurring basis. Level 1 fair value measurement is based upon quoted prices for identical instruments. The values for Level 1 investment securities are generally obtained from an independent third party. On a quarterly basis, we compare the values provided to alternative pricing sources.
Loans: 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.

29

Table of Contents

The following tables list the quantitative fair value information about impaired loans as of:

March 31, 2018
Valuation Technique
Fair Value
Unobservable Input
 
Actual Range
 
 
Discount applied to collateral:
 
 
 
 
Real Estate
 
20% - 30%
 
 
Equipment
 
25% - 35%
 
 
Cash crop inventory
 
30% - 40%
Discounted value
$18,934
Livestock
 
30%
 
 
Other inventory
 
50% - 75%
 
 
Accounts receivable
 
25% - 50%
 
 
Liquor license
 
75%
 
 
Furniture, fixtures & equipment
 
35% - 45%

December 31, 2017
Valuation Technique
Fair Value
Unobservable Input
 
Actual Range
 
 
Discount applied to collateral:
 
 
 
 
Real Estate
 
20% - 30%
 
 
Equipment
 
20% - 35%
 
 
Cash crop inventory
 
30% - 40%
Discounted value
$15,956
Livestock
 
30%
 
 
Other inventory
 
50% - 75%
 
 
Accounts receivable
 
50%
 
 
Liquor license
 
75%
 
 
Furniture, fixtures & equipment
 
35% - 45%
Collateral discount rates may have ranges to accommodate differences in the age of the independent appraisal, broker price opinion, or internal evaluation.
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.
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.

30

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:
 
March 31, 2018

Carrying
Value
 
Estimated
Fair Value
 
Level 1
 
Level 2
 
Level 3
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
16,712

 
$
16,712

 
$
16,712

 
$

 
$

Mortgage loans AFS
359

 
447

 

 
447

 

Gross loans
1,093,002

 
1,075,018

 

 

 
1,075,018

Less allowance for loan and lease losses
8,200

 
8,200

 

 

 
8,200

Net loans
1,084,802

 
1,066,818

 

 

 
1,066,818

Accrued interest receivable
7,134

 
7,134

 
7,134

 

 

Equity securities without readily determinable fair values (1)
23,391

 
N/A

 

 

 

OMSR
2,421

 
2,421

 

 
2,421

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
825,808

 
825,808

 
825,808

 

 

Deposits with stated maturities
472,060

 
460,342

 

 
460,342

 

Borrowed funds
303,113

 
298,139

 

 
298,139

 

Accrued interest payable
676

 
676

 
676

 

 

 
December 31, 2017
 
Carrying
Value
 
Estimated
Fair Value
 
Level 1
 
Level 2
 
Level 3
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
30,848

 
$
30,848

 
$
30,848

 
$

 
$

Mortgage loans AFS
1,560

 
1,587

 

 
1,587

 

Gross loans
1,091,519

 
1,056,906

 

 

 
1,056,906

Less allowance for loan and lease losses
7,700

 
7,700

 

 

 
7,700

Net loans
1,083,819

 
1,049,206

 

 

 
1,049,206

Accrued interest receivable
7,063

 
7,063

 
7,063

 

 

Equity securities without readily determinable fair values (1)
23,454

 
N/A

 

 

 

OMSR
2,409

 
2,409

 

 
2,409

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
811,992

 
811,992

 
811,992

 

 

Deposits with stated maturities
453,266

 
443,892

 

 
443,892

 

Borrowed funds
344,878

 
342,089

 

 
342,089

 

Accrued interest payable
680

 
680

 
680

 

 

(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.

31

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:
 
March 31, 2018
 
December 31, 2017

Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
Recurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AFS securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprises
$
202

 
$

 
$
202

 
$

 
$
216

 
$

 
$
216

 
$

States and political subdivisions
211,633

 

 
211,633

 

 
208,474

 

 
208,474

 

Auction rate money market preferred
3,012

 

 
3,012

 

 
3,049

 

 
3,049

 

Mortgage-backed securities
206,861

 

 
206,861

 

 
208,797

 

 
208,797

 

Collateralized mortgage obligations
126,054

 

 
126,054

 

 
128,194

 

 
128,194

 

Total AFS securities
547,762

 

 
547,762

 

 
548,730

 

 
548,730

 

Equity securities
3,575

 
3,575

 

 

 
3,577

 
3,577

 

 

Derivative instruments
413

 

 
413

 

 
291

 

 
291

 

Nonrecurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans (net of the ALLL)
18,934

 

 

 
18,934

 
15,956

 

 

 
15,956

Total
$
570,684

 
$
3,575

 
$
548,175

 
$
18,934

 
$
568,554

 
$
3,577

 
$
549,021

 
$
15,956

Percent of assets and liabilities measured at fair value
 
 
0.63
%
 
96.06
%
 
3.31
%
 
 
 
0.63
%
 
96.56
%
 
2.81
%
Equity securities are recorded at fair value with changes in fair value recognized through earnings on a recurring basis. For the three month period ended March 31, 2018, we recorded a loss of $2 through earnings. We had no other assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a recurring basis, as of March 31, 2018. We had no assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a nonrecurring basis, as of March 31, 2018.

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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 March 31
 
2018
 
2017

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
$
391

 
$
230

 
$
(3,223
)
 
$
(2,602
)
 
$
30

 
$
164

 
$
(2,972
)
 
$
(2,778
)
OCI before reclassifications
(8,057
)
 
122

 

 
(7,935
)
 
1,677

 
17

 

 
1,694

Tax effect
1,684

 
(26
)
 

 
1,658

 
(450
)
 
(6
)
 

 
(456
)
OCI, net of tax
(6,373
)
 
96

 

 
(6,277
)
 
1,227

 
11

 

 
1,238

Adoption of ASU 2016-01
223

 

 

 
223

 

 

 

 

Balance, March 31
$
(5,759
)
 
$
326

 
$
(3,223
)
 
$
(8,656
)
 
$
1,257

 
$
175

 
$
(2,972
)
 
$
(1,540
)
Included in OCI for the three month period ended March 31, 2018 are changes in unrealized holding gains and losses related to auction rate money market preferred stocks. For the three month period ended March 31, 2017, OCI also includes changes in unrealized holding gains and losses related to 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.
A summary of the components of unrealized holding gains on AFS securities included in OCI follows for the:
 
Three Months Ended March 31
 
2018
 
2017

Auction Rate Money Market 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
$
(37
)
 
$
(8,020
)
 
$
(8,057
)
 
$
355

 
$
1,322

 
$
1,677

Tax effect

 
1,684

 
1,684

 

 
(450
)
 
(450
)
Unrealized gains (losses), net of tax
$
(37
)
 
$
(6,336
)
 
$
(6,373
)
 
$
355

 
$
872

 
$
1,227


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Table of Contents

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

March 31
2018
 
December 31
2017
ASSETS
 
 
 
Cash on deposit at the Bank
$
1,410

 
$
185

Investments in subsidiaries
141,754

 
145,962

Premises and equipment
1,914

 
1,950

Other assets
51,360

 
52,253

TOTAL ASSETS
$
196,438

 
$
200,350

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Other liabilities
$
5,348

 
$
5,445

Shareholders' equity
191,090

 
194,905

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
196,438

 
$
200,350

Interim Condensed Statements of Income
 
Three Months Ended 
 March 31

2018
 
2017
Income
 
 
 
Dividends from subsidiaries
$
2,100

 
$
1,700

Interest income

 
2

Management fee and other
675

 
1,550

Total income
2,775

 
3,252

Expenses
 
 
 
Compensation and benefits
984

 
1,372

Occupancy and equipment
123

 
444

Audit and related fees
69

 
124

Other
394

 
541

Total expenses
1,570

 
2,481

Income before income tax benefit and equity in undistributed earnings of subsidiaries
1,205

 
771

Federal income tax benefit
188

 
316

Income before equity in undistributed earnings of subsidiaries
1,393

 
1,087

Undistributed earnings of subsidiaries
2,069

 
2,049

Net income
$
3,462

 
$
3,136


34

Table of Contents

Interim Condensed Statements of Cash Flows
 
Three Months Ended 
 March 31

2018
 
2017
Operating activities
 
 
 
Net income
$
3,462

 
$
3,136

Adjustments to reconcile net income to cash provided by operations
 
 
 
Undistributed earnings of subsidiaries
(2,069
)
 
(2,049
)
Undistributed earnings of equity securities without readily determinable fair values
63

 
78

Share-based payment awards under equity compensation plan
146

 
178

Depreciation
30

 
39

Changes in operating assets and liabilities which provided (used) cash
 
 
 
Other assets
830

 
74

Accrued interest and other liabilities
(97
)
 
(1,073
)
Net cash provided by (used in) operating activities
2,365

 
383

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

 
249

Sales (purchases) of premises and equipment
6

 
(3
)
Net cash provided by (used in) investing activities
6

 
246

Financing activities
 
 
 
Cash dividends paid on common stock
(2,041
)
 
(1,953
)
Proceeds from the issuance of common stock
1,616

 
1,770

Common stock repurchased
(620
)
 
(1,169
)
Common stock purchased for deferred compensation obligations
(101
)
 
(123
)
Net cash provided by (used in) financing activities
(1,146
)
 
(1,475
)
Increase (decrease) in cash and cash equivalents
1,225

 
(846
)
Cash and cash equivalents at beginning of period
185

 
1,297

Cash and cash equivalents at end of period
$
1,410

 
$
451

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 March 31, 2018 and 2017 and each of the three 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.

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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 month periods ended March 31, 2018 and 2017. This analysis should be read in conjunction with our 2017 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 months ended March 31, 2018, the Corporation reported net income of $3,462 and earnings per common share of $0.44. Net income and earnings per common share for the same period of 2017 was $3,136 and $0.40, respectively. The increase of $326 in year-to-date earnings was driven, in part, by a significant increase in interest income as the result of strong loan growth, which totaled $80,082 during the prior 12 months. Net interest income increased by $690 for the first three months of 2018 in comparison to the same period in 2017. Provision for loan losses increased by $357 for the first three months of 2018 in comparison to the same period in 2017 as a result of a combination of loan growth and an increase in nonperforming agricultural loans. Strong operating expense controls were maintained with expenses increasing by only $145 when comparing the same two periods. In addition, net income in 2018 has benefited from the lower federal statutory tax rate established by the 2017 Tax Act.
As of March 31, 2018, total assets and assets under management were $1,799,592 and $2,532,711, respectively, with both decreasing slightly from December 31, 2017. Assets under management include loans sold and serviced of $262,541 and assets managed by our Investment and Trust Services Department of $470,578. Loans outstanding as of March 31, 2018 totaled $1,093,002. While loans grew as anticipated during the first quarter of 2018, total deposits increased $32,610 which exceeded expectations and allowed us to reduce borrowed funds by $41,765. All regulatory capital ratios for the Bank exceeded the minimum thresholds to be considered a "well capitalized" institution.
Our net yield on interest earning assets (FTE) was 2.95% for the three month period ended March 31, 2018. The decline in our net yield on interest earning assets during the quarter from 3.02% in the prior quarter was driven by a decrease in our FTE yield on nontaxable investment securities due to the lower federal statutory tax rate established by the 2017 Tax Act. The FRB increased short-term interest rates during the first quarter of 2018 and projects further increases in 2018. We anticipate improvements in our net yield on interest earning assets as a result of a combination of projected FRB short-term rate increases, assets repricing faster than liabilities, our asset mix shifting to an increasing percentage of loans compared to investment securities, and strategic growth in loans and other income earning assets. We are committed to increasing earnings and shareholder value through growth in our loan portfolio, growth in our investment and trust services, and increasing our geographical presence while managing operating costs.
Recent Legislation
On December 22, 2017, the Tax Cuts and Jobs Act was enacted. The new law establishes a flat corporate federal statutory income tax rate of 21%, a decline from 34%, and eliminates the corporate alternative minimum tax. The new tax law provides for a wide array of changes with only some believed to have a direct impact on our federal income tax expense. Some of these changes include, but are not limited to, the following items: limits to the deductions for net interest expense, immediate expense (for tax purposes) for certain qualified depreciable assets, elimination or reduction of certain deductions related to meals and entertainment expenses, and limits to the deductibility of deposit insurance premiums.
Reclassifications: Certain amounts reported in the 2017 consolidated financial statements have been reclassified to conform to the 2018 presentation.

36

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:

March 31
2018
 
December 31
2017
 
September 30
2017
 
June 30
2017
 
March 31
2017
INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
Interest income
$
15,121

 
$
15,078

 
$
14,976

 
$
14,498

 
$
13,861

Interest expense
3,401

 
3,435

 
3,200

 
3,028

 
2,831

Net interest income
11,720

 
11,643

 
11,776

 
11,470

 
11,030

Provision for loan losses
384

 
168

 
49

 
9

 
27

Noninterest income
2,487

 
2,710

 
2,698

 
2,788

 
2,616

Noninterest expenses
10,096

 
10,628

 
10,139

 
9,507

 
9,951

Federal income tax expense**
265

 
836

 
750

 
898

 
532

Net income
$
3,462

 
$
2,721

 
$
3,536

 
$
3,844

 
$
3,136

PER SHARE
 
 
 
 
 
 
 
 
 
Basic earnings
$
0.44

 
$
0.35

 
$
0.45

 
$
0.49

 
$
0.40

Diluted earnings
$
0.43

 
$
0.34

 
$
0.44

 
$
0.48

 
$
0.39

Dividends
$
0.26

 
$
0.26

 
$
0.26

 
$
0.25

 
$
0.25

Tangible book value*
$
19.16

 
$
18.96

 
$
18.82

 
$
18.62

 
$
18.34

Quoted market value
 
 
 
 
 
 
 
 
 
High
$
28.25

 
$
29.95

 
$
29.10

 
$
28.45

 
$
29.00

Low
$
26.11

 
$
27.99

 
$
27.65

 
$
27.60

 
$
27.60

Close*
$
27.40

 
$
28.25

 
$
29.00

 
$
28.00

 
$
27.60

Common shares outstanding*
7,894,341

 
7,857,293

 
7,856,664

 
7,862,553

 
7,843,120

PERFORMANCE RATIOS
 
 
 
 
 
 
 
 
 
Return on average total assets
0.77
%
 
0.61
%
 
0.79
%
 
0.87
%
 
0.72
%
Return on average shareholders' equity
7.11
%
 
5.48
%
 
7.11
%
 
7.85
%
 
6.56
%
Return on average tangible shareholders' equity
9.23
%
 
7.33
%
 
9.61
%
 
10.59
%
 
8.77
%
Net interest margin yield (FTE)**
2.95
%
 
3.02
%
 
3.08
%
 
3.03
%
 
2.99
%
BALANCE SHEET DATA*
 
 
 
 
 
 
 
 
 
Gross loans
$
1,093,002

 
$
1,091,519

 
$
1,077,544

 
$
1,048,497

 
$
1,012,920

AFS securities
$
547,762

 
$
548,730

 
$
549,274

 
$
564,197

 
$
586,517

Total assets
$
1,799,592

 
$
1,813,130

 
$
1,791,967

 
$
1,777,298

 
$
1,760,860

Deposits
$
1,297,868

 
$
1,265,258

 
$
1,216,062

 
$
1,210,152

 
$
1,231,061

Borrowed funds
$
303,113

 
$
344,878

 
$
367,027

 
$
360,940

 
$
327,375

Shareholders' equity
$
191,090

 
$
194,905

 
$
196,463

 
$
195,070

 
$
190,976

Gross loans to deposits
84.22
%
 
86.27
%
 
88.61
%
 
86.64
%
 
82.28
%
ASSETS UNDER MANAGEMENT*
 
 
 
 
 
 
 
 
 
Loans sold with servicing retained
$
262,541

 
$
266,789

 
$
268,817

 
$
269,595

 
$
270,217

Assets managed by our Investment and Trust Services Department
$
470,578

 
$
478,146

 
$
467,601

 
$
454,294

 
$
444,749

Total assets under management
$
2,532,711

 
$
2,558,065

 
$
2,528,385

 
$
2,501,187

 
$
2,475,826

ASSET QUALITY*
 
 
 
 
 
 
 
 
 
Nonperforming loans to gross loans
0.63
%
 
0.31
%
 
0.21
%
 
0.26
%
 
0.24
%
Nonperforming assets to total assets
0.40
%
 
0.20
%
 
0.14
%
 
0.17
%
 
0.15
%
ALLL to gross loans
0.75
%
 
0.71
%
 
0.71
%
 
0.72
%
 
0.74
%
CAPITAL RATIOS*
 
 
 
 
 
 
 
 
 
Shareholders' equity to assets
10.62
%
 
10.75
%
 
10.96
%
 
10.98
%
 
10.85
%
Tier 1 leverage
8.69
%
 
8.54
%
 
8.50
%
 
8.50
%
 
8.54
%
Common equity tier 1 capital
12.34
%
 
12.23
%
 
12.20
%
 
12.43
%
 
12.49
%
Tier 1 risk-based capital
12.34
%
 
12.23
%
 
12.20
%
 
12.43
%
 
12.49
%
Total risk-based capital
13.01
%
 
12.86
%
 
12.84
%
 
13.07
%
 
13.14
%
* At end of period
** Calculations are based on a federal income tax rate of 21% in 2018 and 34% for all other periods.

37

Table of Contents

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

March 31
2018
 
March 31
2017
 
March 31
2016
 
March 31
2015
 
March 31
2014
INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
Interest income
$
15,121

 
$
13,861

 
$
13,081

 
$
12,753

 
$
12,693

Interest expense
3,401

 
2,831

 
2,614

 
2,488

 
2,500

Net interest income
11,720

 
11,030

 
10,467

 
10,265

 
10,193

Provision for loan losses
384

 
27

 
156

 
(726
)
 
(242
)
Noninterest income
2,487

 
2,616

 
2,223

 
2,128

 
2,249

Noninterest expenses
10,096

 
9,951

 
9,080

 
8,675

 
8,815

Federal income tax expense**
265

 
532

 
437

 
771

 
560

Net income
$
3,462

 
$
3,136


$
3,017

 
$
3,673

 
$
3,309

PER SHARE
 
 
 
 
 
 
 
 
 
Basic earnings
$
0.44

 
$
0.40

 
$
0.39

 
$
0.47

 
$
0.43

Diluted earnings
$
0.43

 
$
0.39

 
$
0.38

 
$
0.46

 
$
0.42

Dividends
$
0.26

 
$
0.25

 
$
0.24

 
$
0.23

 
$
0.22

Tangible book value*
$
19.16

 
$
18.34

 
$
17.47

 
$
16.84

 
$
15.82

Quoted market value
 
 
 
 
 
 
 
 
 
High
$
28.25

 
$
29.00

 
$
29.90

 
$
23.50

 
$
23.94

Low
$
26.11

 
$
27.60

 
$
27.25

 
$
22.00

 
$
22.25

Close*
$
27.40

 
$
27.60

 
$
28.25

 
$
22.90

 
$
23.00

Common shares outstanding*
7,894,341

 
7,843,120

 
7,809,079

 
7,781,820

 
7,727,547

PERFORMANCE RATIOS
 
 
 
 
 
 
 
 
 
Return on average total assets
0.77
%
 
0.72
%
 
0.72
%
 
0.95
%
 
0.88
%
Return on average shareholders' equity
7.11
%
 
6.56
%
 
6.37
%
 
8.27
%
 
8.04
%
Return on average tangible shareholders' equity
9.23
%
 
8.77
%
 
8.88
%
 
11.30
%
 
10.92
%
Net interest margin yield (FTE)**
2.95
%
 
2.99
%
 
2.98
%
 
3.18
%
 
3.21
%
BALANCE SHEET DATA*
 
 
 
 
 
 
 
 
 
Gross loans
$
1,093,002

 
$
1,012,920

 
$
870,291

 
$
818,493

 
$
811,242

AFS securities
$
547,762

 
$
586,517

 
$
646,513

 
$
598,884

 
$
549,091

Total assets
$
1,799,592

 
$
1,760,860

 
$
1,681,818

 
$
1,571,575

 
$
1,513,371

Deposits
$
1,297,868

 
$
1,231,061

 
$
1,173,507

 
$
1,098,655

 
$
1,065,935

Borrowed funds
$
303,113

 
$
327,375

 
$
307,896

 
$
283,321

 
$
272,536

Shareholders' equity
$
191,090

 
$
190,976

 
$
190,247

 
$
179,653

 
$
165,971

Gross loans to deposits
84.22
%
 
82.28
%
 
74.16
%
 
74.50
%
 
76.11
%
ASSETS UNDER MANAGEMENT*
 
 
 
 
 
 
 
 
 
Loans sold with servicing retained
$
262,541

 
$
270,217

 
$
282,618

 
$
288,448

 
$
292,382

Assets managed by our Investment and Trust Services Department
$
470,578

 
$
444,749

 
$
408,224

 
$
396,802

 
$
358,811

Total assets under management
$
2,532,711

 
$
2,475,826

 
$
2,372,660

 
$
2,256,825

 
$
2,164,564

ASSET QUALITY*
 
 
 
 
 
 
 
 
 
Nonperforming loans to gross loans
0.63
%
 
0.24
%
 
0.12
%
 
0.44
%
 
0.65
%
Nonperforming assets to total assets
0.40
%
 
0.15
%
 
0.08
%
 
0.27
%
 
0.42
%
ALLL to gross loans
0.75
%
 
0.74
%
 
0.86
%
 
1.17
%
 
1.37
%
CAPITAL RATIOS*
 
 
 
 
 
 
 
 
 
Shareholders' equity to assets
10.62
%
 
10.85
%
 
11.31
%
 
11.43
%
 
10.97
%
Tier 1 leverage
8.69
%
 
8.54
%
 
8.44
%
 
8.74
%
 
8.38
%
Common equity tier 1 capital
12.34
%
 
12.49
%
 
13.24
%
 
13.71
%
 
N/A

Tier 1 risk-based capital
12.34
%
 
12.49
%
 
13.24
%
 
13.71
%
 
13.89
%
Total risk-based capital
13.01
%
 
13.14
%
 
13.97
%
 
14.71
%
 
15.14
%
* At end of period
** Calculations are based on a federal income tax rate of 21% in 2018 and 34% for all other periods.

38

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 federal income tax rate of 21% in 2018 and 34% in 2017. 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

March 31, 2018

December 31, 2017

March 31, 2017

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
$
1,076,667


$
11,296


4.20
%

$
1,072,694


$
11,435


4.26
%

$
997,443


$
10,120


4.06
%
Taxable investment securities (1)
355,867


2,160


2.43
%

355,649


2,112


2.38
%

364,251


2,151


2.36
%
Nontaxable investment securities
197,519


1,892


3.83
%

195,391


2,197


4.50
%

205,372


2,316


4.51
%
Fed Funds Sold

 

 
%
 
186

 
1

 
2.15
%
 
2,397

 
4

 
0.67
%
Other
27,160


283


4.17
%

29,818


194


2.60
%

26,929


171


2.54
%
Total earning assets
1,657,213


15,631


3.77
%

1,653,738


15,939


3.86
%

1,596,392


14,762


3.70
%
NONEARNING ASSETS

















Allowance for loan losses
(7,771
)





(7,759
)





(7,480
)




Cash and demand deposits due from banks
19,437






20,218






18,736





Premises and equipment
28,578






28,744






29,238





Accrued income and other assets
91,471






99,219






97,692





Total assets
$
1,788,928






$
1,794,160






$
1,734,578





INTEREST BEARING LIABILITIES

















Interest bearing demand deposits
$
231,308


$
71


0.12
%

$
212,723


$
60


0.11
%

$
213,617


$
53


0.10
%
Savings deposits
354,445


322


0.36
%

352,267


307


0.35
%

354,006


222


0.25
%
Time deposits
463,236


1,653


1.43
%

432,863


1,572


1.45
%

436,003


1,265


1.16
%
Borrowed funds
319,789


1,355


1.69
%

362,946


1,496


1.65
%

328,368


1,291


1.57
%
Total interest bearing liabilities
1,368,778


3,401


0.99
%

1,360,799


3,435


1.01
%

1,331,994


2,831


0.85
%
NONINTEREST BEARING LIABILITIES

















Demand deposits
217,658






224,441






200,598





Other
7,793






10,351






10,841





Shareholders’ equity
194,699






198,569






191,145





Total liabilities and shareholders’ equity
$
1,788,928






$
1,794,160






$
1,734,578





Net interest income (FTE)


$
12,230






$
12,504






$
11,931



Net yield on interest earning assets (FTE)




2.95
%





3.02
%





2.99
%
(1 ) Includes taxable AFS securities and equity securities

39

Table of Contents

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.
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 
 March 31, 2018 Compared to 
 December 31, 2017 
 Increase (Decrease) Due to
 
Three Months Ended 
 March 31, 2018 Compared to 
 March 31, 2017 
 Increase (Decrease) Due to

Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Changes in interest income
 
 
 
 
 
 
 
 
 
 
 
Loans
$
42

 
$
(181
)
 
$
(139
)
 
$
824

 
$
352

 
$
1,176

Taxable investment securities
1

 
47

 
48

 
(50
)
 
59

 
9

Nontaxable investment securities
24

 
(329
)
 
(305
)
 
(86
)
 
(338
)
 
(424
)
Fed Funds Sold

 
(1
)
 
(1
)
 

 
(4
)
 
(4
)
Other
(19
)
 
108

 
89

 
1

 
111

 
112

Total changes in interest income
48

 
(356
)
 
(308
)
 
689

 
180

 
869

Changes in interest expense
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
5

 
6

 
11

 
5

 
13

 
18

Savings deposits
2

 
13

 
15

 

 
100

 
100

Time deposits
109

 
(28
)
 
81

 
83

 
305

 
388

Borrowed funds
(182
)
 
41

 
(141
)
 
(34
)
 
98

 
64

Total changes in interest expense
(66
)
 
32

 
(34
)
 
54

 
516

 
570

Net change in interest margin (FTE)
$
114

 
$
(388
)
 
$
(274
)
 
$
635

 
$
(336
)
 
$
299

Our net yield on interest earning assets decreased during the quarter with yields remaining at low levels. The decline in our yield on interest earning assets during the quarter was driven by a decline in our FTE yield on nontaxable investment securities due to the lower federal statutory tax rate established by the 2017 Tax Act. 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 2018.
 
Average Yield / Rate for the Three Month Periods Ended:

March 31
2018

December 31
2017

September 30
2017

June 30
2017

March 31
2017
Total earning assets
3.77
%
 
3.86
%
 
3.86
%
 
3.77
%
 
3.70
%
Total interest bearing liabilities
0.99
%
 
1.01
%
 
0.93
%
 
0.89
%
 
0.85
%
Net yield on interest earning assets (FTE)
2.95
%

3.02
%
 
3.08
%
 
3.03
%
 
2.99
%
 
Quarter to Date Net Interest Income (FTE)

March 31
2018
 
December 31
2017
 
September 30
2017
 
June 30
2017
 
March 31
2017
Total interest income (FTE)
$
15,631

 
$
15,939

 
$
15,872

 
$
15,399

 
$
14,762

Total interest expense
3,401

 
3,435

 
3,200

 
3,028

 
2,831

Net interest income (FTE)
$
12,230

 
$
12,504

 
$
12,672

 
$
12,371

 
$
11,931


40

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 
 March 31
 
 

2018
 
2017
 
Variance
ALLL at beginning of period
$
7,700

 
$
7,400

 
$
300

Charge-offs
 
 
 
 
 
Commercial and agricultural
5

 
27

 
(22
)
Residential real estate
10

 
43

 
(33
)
Consumer
88

 
74

 
14

Total charge-offs
103

 
144

 
(41
)
Recoveries
 
 
 
 
 
Commercial and agricultural
103

 
133

 
(30
)
Residential real estate
56

 
36

 
20

Consumer
60

 
48

 
12

Total recoveries
219

 
217

 
2

Net loan charge-offs (recoveries)
(116
)
 
(73
)
 
(43
)
Provision for loan losses
384

 
27

 
357

ALLL at end of period
$
8,200

 
$
7,500

 
$
700

Net loan charge-offs (recoveries) to average loans outstanding
(0.01
)%
 
(0.01
)%
 
%
The following table summarizes our charge-offs, recoveries, provisions for loan losses, and ALLL balances as of, and for the three month periods ended:

March 31
2018
 
December 31
2017
 
September 30
2017
 
June 30
2017
 
March 31
2017
Total charge-offs
$
103

 
$
401

 
$
157

 
$
69

 
$
144

Total recoveries
219

 
233

 
208

 
160

 
217

Net loan charge-offs (recoveries)
(116
)
 
168

 
(51
)
 
(91
)
 
(73
)
Net loan charge-offs (recoveries) to average loans outstanding
(0.01
)%
 
0.02
%
 
 %
 
(0.01
)%
 
(0.01
)%
Provision for loan losses
$
384

 
$
168

 
$
49

 
$
9

 
$
27

Provision for loan losses to average loans outstanding
0.04
 %
 
0.02
%
 
 %
 
 %
 
 %
ALLL
$
8,200

 
$
7,700

 
$
7,700

 
$
7,600

 
$
7,500

ALLL as a % of loans at end of period
0.75
 %
 
0.71
%
 
0.71
 %
 
0.72
 %
 
0.74
 %

41

Table of Contents

While we experienced net loan recoveries during the quarter, we also experienced deterioration in credit quality indicators evidenced in part by our level of nonperforming loans. These indicators required an increase in both the ALLL balance and the ALLL as a percentage of loans. During the past year, strong credit quality indicators, low historical loss factors, and net loan recoveries have resulted in modest levels of required reserves. While the ALLL as a percentage of loans has increased only slightly, the balance of the ALLL has increased as a result of our strong loan growth.
The following table illustrates our changes within the two main components of the ALLL as of:

March 31
2018
 
December 31
2017
 
September 30
2017
 
June 30
2017
 
March 31
2017
ALLL
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,503

 
$
2,130

 
$
2,551

 
$
2,455

 
$
2,381

Collectively evaluated for impairment
5,697

 
5,570

 
5,149

 
5,145

 
5,119

Total
$
8,200

 
$
7,700

 
$
7,700

 
$
7,600

 
$
7,500

ALLL to gross loans
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
0.23
%
 
0.20
%
 
0.24
%
 
0.23
%
 
0.24
%
Collectively evaluated for impairment
0.52
%
 
0.51
%
 
0.47
%
 
0.49
%
 
0.50
%
Total
0.75
%
 
0.71
%
 
0.71
%
 
0.72
%
 
0.74
%
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

March 31
2018
 
December 31
2017
 
September 30
2017
 
June 30
2017
 
March 31
2017
Commercial and agricultural
$
9,398

 
$
4,885

 
$
3,600

 
$
4,920

 
$
5,758

Residential real estate
4,614

 
4,881

 
2,201

 
2,358

 
3,168

Consumer
115

 
70

 
52

 
64

 
35

Total
$
14,127

 
$
9,836

 
$
5,853

 
$
7,342

 
$
8,961

Total past due and nonaccrual loans to gross loans
1.29
%
 
0.90
%
 
0.54
%
 
0.70
%
 
0.88
%
While past due and nonaccrual status loans have fluctuated over the last year, they continue to reflect strong loan performance. The recent increase resulted primarily from commercial and agricultural loan activity, which is being closely monitored. 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.

42

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 March 31, 2018 or December 31, 2017.
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 March 31, 2018
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
January 1, 2018
147

 
$
23,284

 
13

 
$
2,913

 
160

 
$
26,197

New modifications
7

 
2,483

 

 

 
7

 
2,483

Principal advances (payments)

 
(387
)
 

 
(92
)
 

 
(479
)
Loans paid off
(9
)
 
(661
)
 

 

 
(9
)
 
(661
)
Partial charge-offs

 

 

 

 

 

Balances charged-off

 

 

 

 

 

Transfers to OREO

 

 

 

 

 

Transfers to accrual status

 

 

 

 

 

Transfers to nonaccrual status
(2
)
 
(369
)
 
2

 
369

 

 

March 31, 2018
143

 
$
24,350

 
15

 
$
3,190

 
158

 
$
27,540


Three Months Ended March 31, 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
3

 
235

 

 

 
3

 
235

Principal advances (payments)

 
(309
)
 

 
(6
)
 

 
(315
)
Loans paid off
(5
)
 
(251
)
 

 

 
(5
)
 
(251
)
Partial charge-offs

 

 

 

 

 

Balances charged-off

 

 

 

 

 

Transfers to OREO

 

 

 

 

 

Transfers to accrual status
1

 
75

 
(1
)
 
(75
)
 

 

Transfers to nonaccrual status
(2
)
 
(92
)
 
2

 
92

 

 

March 31, 2017
150

 
$
20,251

 
6

 
$
800

 
156

 
$
21,051


43

Table of Contents

The following table summarizes our TDRs as of:
 
March 31, 2018
 
December 31, 2017
 
 

Accruing
Interest
 
Nonaccrual
 
Total
 
Accruing
Interest
 
Nonaccrual
 
Total
 
Total
Change
Current
$
22,016

 
$
2,284

 
$
24,300

 
$
21,234

 
$

 
$
21,234

 
$
3,066

Past due 30-59 days
2,283

 
264

 
2,547

 
1,778

 
805

 
2,583

 
(36
)
Past due 60-89 days

 

 

 
219

 
708

 
927

 
(927
)
Past due 90 days or more
51

 
642

 
693

 
53

 
1,400

 
1,453

 
(760
)
Total
$
24,350

 
$
3,190

 
$
27,540

 
$
23,284

 
$
2,913

 
$
26,197

 
$
1,343

Additional disclosures about TDRs are included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
Impaired Loans
The following is a summary of information pertaining to impaired loans as of:
 
March 31, 2018
 
December 31, 2017

Recorded
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
 
Recorded
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
TDRs
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
6,652

 
$
6,952

 
$
591

 
$
5,780

 
$
6,082

 
$
626

Commercial other
2,060

 
2,060

 
23

 
2,219

 
2,219

 
24

Agricultural real estate
8,963

 
8,963

 
141

 
7,913

 
7,913

 

Agricultural other
2,505

 
2,505

 

 
2,685

 
2,685

 

Residential real estate senior liens
7,239

 
7,602

 
1,402

 
7,460

 
7,839

 
1,406

Residential real estate junior liens
36

 
36

 
6

 
44

 
44

 
7

Home equity lines of credit
73

 
373

 

 
79

 
379

 

Consumer secured
12

 
12

 

 
17

 
17

 

Total TDRs
27,540

 
28,503

 
2,163

 
26,197

 
27,178

 
2,063

Other impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
1,760

 
1,822

 
48

 
100

 
161

 

Commercial other
1,203

 
1,203

 
180

 

 

 

Agricultural real estate

 

 

 

 

 

Agricultural other

 

 

 

 

 

Residential real estate senior liens
592

 
857

 
112

 
356

 
620

 
67

Residential real estate junior liens

 

 

 

 

 

Home equity lines of credit

 

 

 

 

 

Consumer secured

 

 

 

 

 

Total other impaired loans
3,555

 
3,882

 
340

 
456

 
781

 
67

Total impaired loans
$
31,095

 
$
32,385

 
$
2,503

 
$
26,653

 
$
27,959

 
$
2,130

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:

March 31
2018
 
December 31
2017
 
September 30
2017
 
June 30
2017
 
March 31
2017
Nonaccrual status loans
$
6,237

 
$
3,027

 
$
1,605

 
$
1,563

 
$
1,138

Accruing loans past due 90 days or more
664

 
395

 
646

 
1,203

 
1,339

Total nonperforming loans
6,901

 
3,422

 
2,251

 
2,766

 
2,477

Foreclosed assets
229

 
291

 
240

 
229

 
158

Total nonperforming assets
$
7,130

 
$
3,713

 
$
2,491

 
$
2,995

 
$
2,635

Nonperforming loans as a % of total loans
0.63
%
 
0.31
%
 
0.21
%
 
0.26
%
 
0.24
%
Nonperforming assets as a % of total assets
0.40
%
 
0.20
%
 
0.14
%
 
0.17
%
 
0.15
%
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. While the level of nonperforming loans has recently increased, it remains low.
Included in the nonaccrual loan balances above were loans currently classified as TDR as of:

March 31
2018
 
December 31
2017
Commercial and agricultural
$
2,592

 
$
2,679

Residential real estate
598

 
234

Total
$
3,190

 
$
2,913

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 March 31, 2018.
We believe that the level of the ALLL is appropriate as of March 31, 2018. 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.

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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 March 31
 
 
 
 
 
Change
 
2018
 
2017
 
$
 
%
Service charges and fees
 
 
 
 
 
 
 
ATM and debit card fees
$
669

 
$
603

 
$
66

 
10.95
 %
NSF and overdraft fees
459

 
441

 
18

 
4.08
 %
Freddie Mac servicing fee
162

 
169

 
(7
)
 
(4.14
)%
Service charges on deposit accounts
85

 
85

 

 
 %
Net OMSR income (loss)
12

 
201

 
(189
)
 
(94.03
)%
All other
101

 
31

 
70

 
225.81
 %
Total service charges and fees
1,488

 
1,530

 
(42
)
 
(2.75
)%
Net gain on sale of mortgage loans
81

 
155

 
(74
)
 
(47.74
)%
Earnings on corporate owned life insurance policies
170

 
180

 
(10
)
 
(5.56
)%
Other
 
 
 
 
 
 
 
Trust and brokerage advisory fees
658

 
571

 
87

 
15.24
 %
Other
90

 
180

 
(90
)
 
(50.00
)%
Total other
748

 
751

 
(3
)
 
(0.40
)%
Total noninterest income
$
2,487

 
$
2,616

 
$
(129
)
 
(4.93
)%
Significant changes in noninterest income are detailed below:
ATM and debit card fees fluctuate from period-to-period based primarily on usage of ATM and debit cards. While we do not anticipate significant changes to our ATM and debit card fee transaction charges, we do expect that fee income will continue to increase in 2018 as the trend of ATM and debit card usage continues to increase.
An OMSR asset represents the present value of the amount by which the estimated future net cash flows from servicing mortgage loans that were sold on a servicing-retained basis exceeds the cost of servicing those mortgage loans.  OMSR income (loss) results when the OMSR value changes.  Generally, rising residential mortgage loan offering rates result in decreased prepayments in the servicing-retained portfolio, which results in increased estimated future net cash flows.  OMSR income may increase during the remainder of 2018, primarily as a result of expected offering rate increases, but may not exceed 2017 OMSR income.
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 2018 but may not exceed 2017 levels.
In recent periods, we have invested considerable efforts to increase our market penetration with investment and trust services. We anticipate that this fee income will continue to increase during the remainder of 2018 and exceed 2017 levels.
The fluctuations in all other and other income is spread throughout various categories, none of which are individually significant.

46

Table of Contents

Significant noninterest expense account balances are highlighted in the following table with additional descriptions of significant fluctuations:
 
Three Months Ended March 31

 
 
 
 
Change
 
2018
 
2017
 
$
 
%
Compensation and benefits
 
 
 
 
 
 
 
Employee salaries
$
4,184

 
$
4,161

 
$
23

 
0.55
 %
Employee benefits
1,310

 
1,396

 
(86
)
 
(6.16
)%
Total compensation and benefits
5,494

 
5,557

 
(63
)
 
(1.13
)%
Furniture and equipment
 
 
 
 
 
 
 
Service contracts
506

 
478

 
28

 
5.86
 %
Depreciation
498

 
512

 
(14
)
 
(2.73
)%
Computer expense
424

 
310

 
114

 
36.77
 %
All other
51

 
44

 
7

 
15.91
 %
Total furniture and equipment
1,479

 
1,344

 
135

 
10.04
 %
Occupancy
 
 
 
 
 
 
 
Depreciation
219

 
210

 
9

 
4.29
 %
Outside services
185

 
199

 
(14
)
 
(7.04
)%
Utilities
152

 
143

 
9

 
6.29
 %
Property taxes
145

 
146

 
(1
)
 
(0.68
)%
All other
123

 
139

 
(16
)
 
(11.51
)%
Total occupancy
824

 
837

 
(13
)
 
(1.55
)%
Other
 
 
 
 
 
 
 
Consulting fees
250

 
205

 
45

 
21.95
 %
ATM and debit card fees
232

 
216

 
16

 
7.41
 %
Director fees
209

 
209

 

 
 %
Audit and related fees
202

 
198

 
4

 
2.02
 %
FDIC insurance premiums
164

 
153

 
11

 
7.19
 %
Donations and community relations
151

 
130

 
21

 
16.15
 %
Loan underwriting fees
149

 
117

 
32

 
27.35
 %
Postage and freight
131

 
109

 
22

 
20.18
 %
Education and travel
115

 
96

 
19

 
19.79
 %
Marketing costs
110

 
89

 
21

 
23.60
 %
All other
586

 
691

 
(105
)
 
(15.20
)%
Total other
2,299

 
2,213

 
86

 
3.89
 %
Total noninterest expenses
$
10,096

 
$
9,951

 
$
145

 
1.46
 %
Significant changes in noninterest expenses are detailed below:
The decline in employee benefits is related to health care costs as a result of lower than anticipated claims. Employee benefits are expected to increase moderately during the remainder of 2018 as a result of anticipated increases in health care costs.
Computer expense increased in 2018 due to data and system upgrades, additional network security costs, and one-time implementation costs. Expenses in 2018 are expected to continue to exceed 2017 levels.
The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.

47

Table of Contents

Analysis of Changes in Financial Condition

March 31
2018
 
December 31
2017
 
$ Change
 
% Change
(unannualized)
ASSETS
 
 
 
 
 
 
 
Cash and cash equivalents
$
16,712

 
$
30,848

 
$
(14,136
)
 
(45.82
)%
AFS securities
 
 
 
 
 
 
 
Amortized cost of AFS securities
555,001

 
547,912

 
7,089

 
1.29
 %
Unrealized gains (losses) on AFS securities
(7,239
)
 
818

 
(8,057
)
 
N/M

AFS securities
547,762

 
548,730

 
(968
)
 
(0.18
)%
Equity securities, at fair value
3,575

 
3,577

 
(2
)
 
(0.06
)%
Mortgage loans AFS
359

 
1,560

 
(1,201
)
 
(76.99
)%
Loans
 
 
 
 


 
 
Gross loans
1,093,002

 
1,091,519

 
1,483

 
0.14
 %
Less allowance for loan and lease losses
8,200

 
7,700

 
500

 
6.49
 %
Net loans
1,084,802

 
1,083,819

 
983

 
0.09
 %
Premises and equipment
28,493

 
28,450

 
43

 
0.15
 %
Corporate owned life insurance policies
27,196

 
27,026

 
170

 
0.63
 %
Accrued interest receivable
7,134

 
7,063

 
71

 
1.01
 %
Equity securities without readily determinable fair values
23,391

 
23,454

 
(63
)
 
(0.27
)%
Goodwill and other intangible assets
48,522

 
48,547

 
(25
)
 
(0.05
)%
Other assets
11,646

 
10,056

 
1,590

 
15.81
 %
TOTAL ASSETS
$
1,799,592

 
$
1,813,130

 
$
(13,538
)
 
(0.75
)%
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Deposits
$
1,297,868

 
$
1,265,258

 
$
32,610

 
2.58
 %
Borrowed funds
303,113

 
344,878

 
(41,765
)
 
(12.11
)%
Accrued interest payable and other liabilities
7,521

 
8,089

 
(568
)
 
(7.02
)%
Total liabilities
1,608,502

 
1,618,225

 
(9,723
)
 
(0.60
)%
Shareholders’ equity
191,090

 
194,905

 
(3,815
)
 
(1.96
)%
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,799,592

 
$
1,813,130

 
$
(13,538
)
 
(0.75
)%
As shown above, total assets have decreased since December 31, 2017. As expected, gross loans increased only slightly during the first quarter of 2018. While generating quality loans in a competitive market continues to be challenging, we expect that loans will continue to grow in 2018. During the first three months of 2018, we have experienced deposit growth which allowed us to reduce borrowed funds.
The following table outlines the changes in loans:

March 31
2018
 
December 31
2017
 
$ Change
 
% Change
(unannualized)
Commercial
$
643,636

 
$
634,759

 
$
8,877

 
1.40
 %
Agricultural
122,330

 
128,269

 
(5,939
)
 
(4.63
)%
Residential real estate
270,150

 
272,368

 
(2,218
)
 
(0.81
)%
Consumer
56,886

 
56,123

 
763

 
1.36
 %
Total
$
1,093,002

 
$
1,091,519

 
$
1,483

 
0.14
 %

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Table of Contents

The following table displays loan balances as of:

March 31
2018
 
December 31
2017
 
September 30
2017
 
June 30
2017
 
March 31
2017
Commercial
$
643,636

 
$
634,759

 
$
620,135

 
$
600,584

 
$
576,822

Agricultural
122,330

 
128,269

 
132,998

 
130,954

 
126,049

Residential real estate
270,150

 
272,368

 
271,480

 
270,207

 
267,141

Consumer
56,886

 
56,123

 
52,931

 
46,752

 
42,908

Total
$
1,093,002

 
$
1,091,519

 
$
1,077,544

 
$
1,048,497

 
$
1,012,920

While competition for commercial loans continues to be strong, we experienced significant growth in this segment of the portfolio during 2017 and anticipate continued growth during 2018. Residential real estate and consumer loans have also experienced growth over the last year and are both expected to increase during 2018.
The following table outlines the changes in deposits:

March 31
2018
 
December 31
2017
 
$ Change
 
% Change
(unannualized)
Noninterest bearing demand deposits
$
223,798

 
$
237,511

 
$
(13,713
)
 
(5.77
)%
Interest bearing demand deposits
235,965

 
231,666

 
4,299

 
1.86
 %
Savings deposits
366,045

 
342,815

 
23,230

 
6.78
 %
Certificates of deposit
338,219

 
331,718

 
6,501

 
1.96
 %
Brokered certificates of deposit
114,656

 
102,808

 
11,848

 
11.52
 %
Internet certificates of deposit
19,185

 
18,740

 
445

 
2.37
 %
Total
$
1,297,868

 
$
1,265,258

 
$
32,610

 
2.58
 %
The following table displays deposit balances as of:

March 31
2018
 
December 31
2017
 
September 30
2017
 
June 30
2017
 
March 31
2017
Noninterest bearing demand deposits
$
223,798

 
$
237,511

 
$
212,608

 
$
210,122

 
$
207,448

Interest bearing demand deposits
235,965

 
231,666

 
220,601

 
212,365

 
216,975

Savings deposits
366,045

 
342,815

 
358,358

 
357,756

 
365,287

Certificates of deposit
338,219

 
331,718

 
309,778

 
314,482

 
320,345

Brokered certificates of deposit
114,656

 
102,808

 
95,979

 
94,948

 
98,442

Internet certificates of deposit
19,185

 
18,740

 
18,738

 
20,479

 
22,564

Total
$
1,297,868

 
$
1,265,258

 
$
1,216,062

 
$
1,210,152

 
$
1,231,061

Deposit demand continues to be driven by non-contractual deposits, such as demand and savings deposits, with certificates of deposit and Internet certificates of deposit accounts also experiencing growth in recent periods. Brokered certificates of deposit offer another source of funding and fluctuate from period-to-period based on our funding needs.

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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. The following table displays fair values of AFS securities as of:

March 31
2018
 
December 31
2017
 
September 30
2017
 
June 30
2017
 
March 31
2017
Government sponsored enterprises
$
202

 
$
216

 
$
232

 
$
281

 
$
10,264

States and political subdivisions
211,633

 
208,474

 
213,457

 
222,093

 
222,777

Auction rate money market preferred
3,012

 
3,049

 
3,172

 
3,095

 
2,977

Mortgage-backed securities
206,861

 
208,797

 
215,914

 
221,957

 
229,774

Collateralized mortgage obligations
126,054

 
128,194

 
116,499

 
116,771

 
120,725

Total
$
547,762

 
$
548,730

 
$
549,274

 
$
564,197

 
$
586,517

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:

March 31
2018
 
December 31
2017
 
September 30
2017
 
June 30
2017
 
March 31
2017
FHLB advances
$
260,000

 
$
290,000

 
$
310,000

 
$
310,000

 
$
270,000

Securities sold under agreements to repurchase without stated maturity dates
32,913

 
54,878

 
54,977

 
49,950

 
57,375

Federal funds purchased
10,200

 

 
2,050

 
990

 

Total
$
303,113

 
$
344,878

 
$
367,027

 
$
360,940

 
$
327,375

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:

March 31
2018
 
December 31
2017
Unfunded commitments under lines of credit
$
184,040

 
$
184,317

Commitments to grant loans
37,838

 
24,782

Commercial and standby letters of credit
1,622

 
1,622

Total
$
223,500

 
$
210,721

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 that may be 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

50

Table of Contents

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.
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.
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 59,560 shares or $1,616 of common stock during the first three months of 2018, as compared to 63,866 shares or $1,770 of common stock during the same period in 2017. 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 $146 and $178 during the three month periods ended March 31, 2018 and 2017, respectively.
We have a publicly announced common stock repurchase plan. Pursuant to this plan, we repurchased 22,512 shares or $620 of common stock during the first three months of 2018 and 41,815 shares or $1,169 during the first three months of 2017. As of March 31, 2018, we were authorized to repurchase up to an additional 193,159 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 8.69% as of March 31, 2018.
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:
 
March 31, 2018
 
December 31, 2017

Actual
 
Minimum Required
 
Actual
 
Minimum Required
Common equity tier 1 capital
12.340
%
 
6.375
%
 
12.230
%
 
5.750
%
 
 
 
 
 
 
 
 
Tier 1 capital
12.340
%
 
7.875
%
 
12.230
%
 
7.250
%
Tier 2 capital
0.670
%
 
2.000
%
 
0.630
%
 
2.000
%
Total Capital
13.010
%
 
9.875
%
 
12.860
%
 
9.250
%
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 March 31, 2018, the Bank exceeded these minimum capital requirements.

51

Table of Contents

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 $285,657 or 15.87% of assets as of March 31, 2018, compared to $293,188 or 16.17% as of December 31, 2017. 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 could vary 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 March 31, 2018, we had available lines of credit of $153,347.
The following table summarizes our sources and uses of cash for the three month period ended March 31:

2018
 
2017
 
$ Variance
Net cash provided by (used in) operating activities
$
5,810

 
$
4,387

 
$
1,423

Net cash provided by (used in) investing activities
(9,645
)
 
(33,448
)
 
23,803

Net cash provided by (used in) financing activities
(10,301
)
 
24,227

 
(34,528
)
Increase (decrease) in cash and cash equivalents
(14,136
)
 
(4,834
)
 
(9,302
)
Cash and cash equivalents January 1
30,848

 
22,894

 
7,954

Cash and cash equivalents March 31
$
16,712

 
$
18,060

 
$
(1,348
)

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Table of Contents

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 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 March 31, 2018, 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 March 31, 2018, 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:

March 31, 2018

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
(2.11
)%
 
1.57
%
 
2.80
%
 
4.59
%
 
5.82
%
 
(2.11
)%
 
1.51
%
 
2.26
%
 
3.36
%
 
2.84
%

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December 31, 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
(2.43
)%
 
2.36
%
 
4.18
%
 
5.99
%
 
7.94
%
 
(2.29
)%
 
2.61
%
 
4.17
%
 
5.39
%
 
6.09
%
The following tables provide information about assets and liabilities that are sensitive to changes in interest rates as of March 31, 2018 and December 31, 2017. 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.

March 31, 2018
 
2019
 
2020
 
2021
 
2022
 
2023
 
Thereafter
 
Total
 
Fair Value
Rate sensitive assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest bearing assets
$
873

 
$
100

 
$

 
$

 
$

 
$

 
$
973

 
$
973

Average interest rates
1.65
%
 
0.35
%
 
%
 
%
 
%
 
%
 
1.51
%
 
 
AFS securities
$
93,159

 
$
72,294

 
$
73,938

 
$
67,490

 
$
71,380

 
$
169,501

 
$
547,762

 
$
547,762

Average interest rates
1.62
%
 
2.51
%
 
2.64
%
 
2.59
%
 
2.41
%
 
2.73
%
 
2.44
%
 
 
Equity securities
$

 
$

 
$

 
$

 
$

 
$
3,575

 
$
3,575

 
$
3,575

Average interest rates
%
 
%
 
%
 
%
 
%
 
4.00
%
 
4.00
%
 
 
Fixed interest rate loans (1)
$
158,607

 
$
119,453

 
$
121,647

 
$
125,559

 
$
115,409

 
$
212,301

 
$
852,976

 
$
815,432

Average interest rates
4.13
%
 
4.39
%
 
4.30
%
 
4.22
%
 
4.35
%
 
4.04
%
 
4.21
%
 
 
Variable interest rate loans (1)
$
70,655

 
$
34,579

 
$
25,830

 
$
25,432

 
$
20,902

 
$
62,628

 
$
240,026

 
$
234,761

Average interest rates
5.54
%
 
4.98
%
 
5.19
%
 
4.63
%
 
4.58
%
 
3.55
%
 
4.72
%
 
 
Rate sensitive liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate borrowed funds
$
113,113

 
$
55,000

 
$
25,000

 
$
60,000

 
$
30,000

 
$
10,000

 
$
293,113

 
$
288,240

Average interest rates
1.35
%
 
1.61
%
 
1.84
%
 
1.93
%
 
2.86
%
 
1.17
%
 
1.71
%
 
 
Variable rate borrowed funds
$

 
$

 
$

 
$
10,000

 
$

 
$

 
$
10,000

 
$
9,899

Average interest rates
%
 
%
 
%
 
2.15
%
 
%
 
%
 
2.15
%
 
 
Savings and NOW accounts
$
114,580

 
$
44,704

 
$
39,996

 
$
35,812

 
$
32,086

 
$
334,832

 
$
602,010

 
$
602,010

Average interest rates
0.26
%
 
0.25
%
 
0.25
%
 
0.25
%
 
0.24
%
 
0.29
%
 
0.27
%
 
 
Fixed interest rate certificates of deposit
$
236,378

 
$
80,339

 
$
36,846

 
$
55,363

 
$
37,076

 
$
18,748

 
$
464,750

 
$
453,066

Average interest rates
1.25
%
 
1.60
%
 
1.64
%
 
1.78
%
 
1.87
%
 
2.05
%
 
1.48
%
 
 
Variable interest rate certificates of deposit
$
2,265

 
$
4,956

 
$
89

 
$

 
$

 
$

 
$
7,310

 
$
7,276

Average interest rates
1.59
%
 
2.12
%
 
%
 
%
 
%
 
%
 
1.95
%
 
 

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December 31, 2017
 
2018
 
2019
 
2020
 
2021
 
2022
 
Thereafter
 
Total
 
Fair Value
Rate sensitive assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest bearing assets
$
5,481

 
$

 
$
100

 
$

 
$

 
$

 
$
5,581

 
$
5,581

Average interest rates
1.65
%
 
%
 
0.35
%
 
%
 
%
 
%
 
1.63
%
 
 
AFS securities
$
95,000

 
$
72,551

 
$
71,591

 
$
68,127

 
$
60,607

 
$
180,854

 
$
548,730

 
$
548,730

Average interest rates
2.33
%
 
2.46
%
 
2.59
%
 
2.58
%
 
2.38
%
 
2.56
%
 
2.49
%
 
 
Equity securities
$

 
$

 
$

 
$

 
$

 
$
3,577

 
$
3,577

 
$
3,577

Average interest rates
%
 
%
 
%
 
%
 
%
 
4.00
%
 
4.00
%
 
 
Fixed interest rate loans (1)
$
153,100

 
$
118,068

 
$
114,872

 
$
129,992

 
$
116,779

 
$
222,971

 
$
855,782

 
$
825,855

Average interest rates
4.12
%
 
4.34
%
 
4.24
%
 
4.16
%
 
4.34
%
 
4.01
%
 
4.17
%
 
 
Variable interest rate loans (1)
$
70,738

 
$
35,473

 
$
27,164

 
$
25,494

 
$
20,158

 
$
56,710

 
$
235,737

 
$
231,051

Average interest rates
5.48
%
 
4.79
%
 
4.91
%
 
4.43
%
 
4.39
%
 
3.72
%
 
4.68
%
 
 
Rate sensitive liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate borrowed funds
$
124,878

 
$
85,000

 
$
35,000

 
$
50,000

 
$
20,000

 
$
20,000

 
$
334,878

 
$
332,146

Average interest rates
1.15
%
 
1.87
%
 
1.80
%
 
1.91
%
 
1.97
%
 
2.54
%
 
1.65
%
 
 
Variable rate borrowed funds
$

 
$

 
$

 
$
10,000

 
$

 
$

 
$
10,000

 
$
9,943

Average interest rates
%
 
%
 
%
 
1.72
%
 
%
 
%
 
1.72
%
 
 
Savings and NOW accounts
$
49,140

 
$
44,096

 
$
39,607

 
$
35,611

 
$
32,051

 
$
373,976

 
$
574,481

 
$
574,481

Average interest rates
0.22
%
 
0.22
%
 
0.22
%
 
0.22
%
 
0.21
%
 
0.27
%
 
0.25
%
 
 
Fixed interest rate certificates of deposit
$
188,598

 
$
109,047

 
$
37,604

 
$
50,814

 
$
38,843

 
$
21,840

 
$
446,746

 
$
437,400

Average interest rates
1.05
%
 
1.57
%
 
1.62
%
 
1.76
%
 
1.85
%
 
2.05
%
 
1.42
%
 
 
Variable interest rate certificates of deposit
$
2,414

 
$
4,106

 
$

 
$

 
$

 
$

 
$
6,520

 
$
6,492

Average interest rates
1.40
%
 
1.66
%
 
%
 
%
 
%
 
%
 
1.56
%
 
 
 (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 March 31, 2018, 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 March 31, 2018, 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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Table of Contents

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, 2017.
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 20, 2017, 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 March 31, 2018, 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, December 31
 
 
 
 
 
 
215,671

January 1 - 31
8,958

 
$
28.02

 
8,958

 
206,713

February 1 - 28
6,522

 
27.60

 
6,522

 
200,191

March 1 - 31
7,032

 
26.88

 
7,032

 
193,159

Balance, March 31
22,512

 
$
27.54

 
22,512

 
193,159

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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Table of Contents

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.

57

Table of Contents

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:
May 4, 2018
 
 
/s/ Jae A. Evans
 
 
 
 
Jae A. Evans
 
 
 
 
President, Chief Executive Officer
 
 
 
 
(Principal Executive Officer)
 
 
 
 
 
Date:
May 4, 2018
 
 
/s/ Neil M. McDonnell
 
 
 
 
Neil M. McDonnell
 
 
 
 
Chief Financial Officer
 
 
 
 
(Principal Financial Officer)

58