Docoh
Loading...

ISBA ISABELLA BANK

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ýQuarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
For the quarterly period ended March 31, 2020
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)
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
NoneN/AN/A
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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    ý  Yes    ¨  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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 ¨
     
Non-accelerated filer ý Smaller reporting company ý
     
    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 7,927,845 as of April 28, 2020.



ISABELLA BANK CORPORATION
QUARTERLY REPORT ON FORM 10-Q

2


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 Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended and Rule 3b-6 promulgated thereunder. 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, federal or state tax laws, monetary and fiscal policy, a health crisis, the quality or composition of the loan or investment portfolio, demand for loan products, fluctuation in the value of collateral securing our loan portfolio, deposit flows, competition, cybersecurity risk, 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.
ACL: Allowance for credit losses FTE: Fully taxable equivalent
AFS: Available-for-sale GAAP: U.S. generally accepted accounting principles
ALLL: Allowance for loan and lease losses IFRS: International Financial Reporting Standards
AOCI: Accumulated other comprehensive income IRR: Interest rate risk
ASC: FASB Accounting Standards Codification ISDA: International Swaps and Derivatives Association
ASU: FASB Accounting Standards Update LIBOR: London Interbank Offered Rate
ATM: Automated teller machine N/A: Not applicable
BHC Act: Bank Holding Company Act of 1956 N/M: Not meaningful
CARES Act: Coronavirus Aid, Relief, and Economic Security Act NAV: Net asset value
CECL: Current expected credit losses NSF: Non-sufficient funds
CFPB: Consumer Financial Protection Bureau OCI: Other comprehensive income (loss)
CIK: Central Index Key OMSR: Originated mortgage servicing rights
COVID-19: Coronavirus disease 2019 OREO: Other real estate owned
CRA: Community Reinvestment Act OTTI: Other-than-temporary impairment
DIF: Deposit Insurance Fund PBO: Projected benefit obligation
DIFS: Department of Insurance and Financial Services PCAOB: Public Company Accounting Oversight Board
Directors Plan: Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors PPP: Paycheck Protection Program
Dividend Reinvestment Plan: Isabella Bank Corporation Stockholder Dividend Reinvestment Plan and Employee Stock Purchase Plan Rabbi Trust: A trust established to fund our Directors Plan
Exchange Act: Securities Exchange Act of 1934 SBA: Small Business Administration
FASB: Financial Accounting Standards Board SEC: U.S. Securities and Exchange Commission
FDIC: Federal Deposit Insurance Corporation SOX: Sarbanes-Oxley Act of 2002
FFIEC: Federal Financial Institutions Examinations Council Tax Act: Tax Cuts and Jobs Act, enacted December 22, 2017
FRB: Federal Reserve Bank TDR: Troubled debt restructuring
FHLB: Federal Home Loan Bank XBRL: eXtensible Business Reporting Language
Freddie Mac: Federal Home Loan Mortgage Corporation Yield Curve: U.S. Treasury Yield Curve

3


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

March 31
2020
 December 31
2019
ASSETS   
Cash and cash equivalents   
Cash and demand deposits due from banks$19,160
 $20,311
Interest bearing balances due from banks77,591
 40,261
Total cash and cash equivalents96,751
 60,572
AFS securities, at fair value407,189
 429,839
Mortgage loans AFS1,228
 904
Loans   
Commercial695,278
 700,941
Agricultural108,856
 116,920
Residential real estate302,016
 298,569
Consumer69,786
 70,140
Gross loans1,175,936
 1,186,570
Less allowance for loan and lease losses8,697
 7,939
Net loans1,167,239
 1,178,631
Premises and equipment25,946
 26,242
Corporate owned life insurance policies27,691
 28,455
Accrued interest receivable7,022
 6,501
Equity securities without readily determinable fair values21,535
 21,629
Goodwill and other intangible assets48,366
 48,379
Other assets12,937
 13,046
TOTAL ASSETS$1,815,904
 $1,814,198
LIABILITIES AND SHAREHOLDERS’ EQUITY   
Deposits   
Noninterest bearing$249,424
 $249,152
Interest bearing demand deposits237,392
 229,865
Certificates of deposit under $250 and other savings739,925
 739,023
Certificates of deposit over $25095,342
 95,811
Total deposits1,322,083
 1,313,851
Borrowed funds263,171
 275,999
Accrued interest payable and other liabilities15,152
 14,166
Total liabilities1,600,406
 1,604,016
Shareholders’ equity   
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,921,291 shares (including 44,687 shares held in the Rabbi Trust) in 2020 and 7,910,804 shares (including 27,069 shares held in the Rabbi Trust) in 2019140,945
 141,069
Shares to be issued for deferred compensation obligations4,802
 5,043
Retained earnings63,041
 62,099
Accumulated other comprehensive income (loss)6,710
 1,971
Total shareholders’ equity215,498
 210,182
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY$1,815,904
 $1,814,198




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

4


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

Three Months Ended 
 March 31
 2020 2019
Interest income   
Loans, including fees$13,254
 $12,891
AFS securities   
Taxable1,489
 1,958
Nontaxable1,053
 1,253
Federal funds sold and other405
 379
Total interest income16,201
 16,481
Interest expense   
Deposits2,791
 2,718
Borrowings1,408
 1,574
Total interest expense4,199
 4,292
Net interest income12,002
 12,189
Provision for loan losses788
 34
Net interest income after provision for loan losses11,214
 12,155
Noninterest income   
Service charges and fees1,353
 1,461
Investment and trust advisory fees572
 677
Gains from redemption of corporate owned life insurance policies524
 
Earnings on corporate owned life insurance policies182
 184
Net gain on sale of mortgage loans151
 93
Other216
 75
Total noninterest income2,998
 2,490
Noninterest expenses   
Compensation and benefits5,869
 5,722
Furniture and equipment1,461
 1,494
Occupancy867
 930
Other2,748
 2,654
Total noninterest expenses10,945
 10,800
Income before federal income tax expense3,267
 3,845
Federal income tax expense203
 349
NET INCOME$3,064
 $3,496
Earnings per common share   
Basic$0.39
 $0.44
Diluted$0.38
 $0.43
Cash dividends per common share$0.27
 $0.26






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

5


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

Three Months Ended 
 March 31
 2020 2019
Net income$3,064
 $3,496
Unrealized gains (losses) on AFS securities arising during the period6,311
 5,954
Reclassification adjustment for net (gains) losses included in net income(71) 
Tax effect (1)
(1,393) (1,195)
Unrealized gains (losses) on AFS securities, net of tax4,847
 4,759
Unrealized gains (losses) on derivative instruments arising during the period(136) (81)
Tax effect (1)
28
 17
Unrealized gains (losses) on derivative instruments, net of tax(108) (64)
Other comprehensive income (loss), net of tax4,739
 4,695
Comprehensive income (loss)$7,803
 $8,191
(1) 
See “Note 9 – Accumulated Other Comprehensive Income” for tax effect reconciliation.
























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

6


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, 20197,870,969
 $140,416
 $5,431
 $57,357
 $(7,685) $195,519
Comprehensive income (loss)
 
 
 3,496
 4,695
 8,191
Issuance of common stock61,405
 1,433
 
 
 
 1,433
Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations
 268
 (268) 
 
 
Share-based payment awards under equity compensation plan
 
 131
 
 
 131
Common stock purchased for deferred compensation obligations
 (186) 
 
 
 (186)
Common stock repurchased pursuant to publicly announced repurchase plan(26,296) (632) 
 
 
 (632)
Cash dividends paid ($0.26 per common share)
 
 
 (2,043) 
 (2,043)
Balance, March 31, 20197,906,078
 $141,299
 $5,294
 $58,810
 $(2,990) $202,413
Balance, January 1, 20207,910,804
 $141,069
 $5,043
 $62,099
 $1,971
 $210,182
Comprehensive income (loss)
 
 
 3,064
 4,739
 7,803
Issuance of common stock69,907
 1,330
 
 
 
 1,330
Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations
 364
 (364) 
 
 
Share-based payment awards under equity compensation plan
 
 123
 
 
 123
Common stock purchased for deferred compensation obligations
 (650) 
 
 
 (650)
Common stock repurchased pursuant to publicly announced repurchase plan(59,420) (1,168) 
 
 
 (1,168)
Cash dividends paid ($0.27 per common share)
 
 
 (2,122) 
 (2,122)
Balance, March 31, 20207,921,291
 $140,945
 $4,802
 $63,041
 $6,710
 $215,498















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

7


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

Three Months Ended 
 March 31
 2020 2019
OPERATING ACTIVITIES   
Net income$3,064
 $3,496
Reconciliation of net income to net cash provided by operating activities:   
Undistributed earnings of equity securities without readily determinable fair values94
 57
Provision for loan losses788
 34
Depreciation668
 731
Amortization of OMSR97
 44
Amortization of acquisition intangibles13
 19
Net amortization of AFS securities444
 435
Net gains on sale of AFS securities(71) 
Net gain on sale of mortgage loans(151) (93)
OMSR impairment loss245
 
Net gains on foreclosed assets(42) (33)
Increase in cash value of corporate owned life insurance policies, net of expenses(170) (173)
Gains from redemption of corporate owned life insurance policies(524) 
Share-based payment awards under equity compensation plan123
 131
Origination of loans held-for-sale(8,890) (6,520)
Proceeds from loan sales8,717
 6,826
Net changes in operating assets and liabilities which provided (used) cash:   
Accrued interest receivable(521) (823)
Other assets(379) (1,492)
Accrued interest payable and other liabilities(111) 437
Net cash provided by (used in) operating activities3,394
 3,076
INVESTING ACTIVITIES   
Activity in AFS securities   
Sales26,855
 
Maturities, calls, and principal payments12,674
 11,824
Purchases(11,012) (6,313)
Net loan principal (originations) collections10,487
 (16,373)
Proceeds from sales of foreclosed assets51
 224
Purchases of premises and equipment(372) (340)
Proceeds from redemption of corporate owned life insurance policies1,458
 
Funding of low income housing tax credit investments(150) (117)
Net cash provided by (used in) investing activities39,991
 (11,095)

8


INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
 Three Months Ended 
 March 31
 2020 2019
FINANCING ACTIVITIES   
Net increase (decrease) in deposits$8,232
 $(14,730)
Net increase (decrease) in borrowed funds(12,828) (28,615)
Cash dividends paid on common stock(2,122) (2,043)
Proceeds from issuance of common stock1,330
 1,433
Common stock repurchased(1,168) (632)
Common stock purchased for deferred compensation obligations(650) (186)
Net cash provided by (used in) financing activities(7,206) (44,773)
Increase (decrease) in cash and cash equivalents36,179
 (52,792)
Cash and cash equivalents at beginning of period60,572
 73,471
Cash and cash equivalents at end of period$96,751

$20,679
SUPPLEMENTAL CASH FLOWS INFORMATION:   
Interest paid$4,214
 $4,227
SUPPLEMENTAL NONCASH INFORMATION:   
Transfers of loans to foreclosed assets$117
 $237




















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

9


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 the “Corporation”, “Isabella”, “we”, “our”, “us”, and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiary. References to Isabella Bank or the “Bank” refer to Isabella Bank Corporation’s subsidiary, Isabella Bank.
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2019.
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, 2019.
Reclassifications: Certain amounts reported in the interim 2019 consolidated financial statements have been reclassified to conform with the 2020 presentation.
Note 2 – Accounting Standards Updates
Recently Adopted
ASU No. 2018-13: “Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement”
In August 2018, ASU No. 2018-13 was issued and provided updated framework related to fair value disclosures. For entities required to make disclosures about recurring or nonrecurring fair value measurements, the update provides disclosure modifications which include the removal, modification and addition of specific disclosure requirements.
The new authoritative guidance was effective January 1, 2020 and did not have a significant impact on our financial statement disclosures.
ASU No. 2018-15: “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract”
In August 2018, ASU No. 2018-15 was issued and provided guidance on the accounting for implementation, setup, and
other upfront costs (collectively referred to as implementation costs) for entities that are a customer in a hosting arrangement that is a service contract. The guidance also provides clarification on requirements to capitalize implementation costs and the required accounting for expenses related to capitalization of implementation costs.
The new authoritative guidance was effective January 1, 2020. Based on the prospective approach, we will review future arrangements to determine the appropriate treatment under this guidance. These changes are not expected to have a significant impact on our operating results or financial statement disclosures.
Pending
ASU No. 2016-13: “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”
In June 2016, ASU No. 2016-13 was issued and 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.

10


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 requires disclosure of 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 was originally effective for interim and annual periods beginning after December 15, 2019. Effective October 16, 2019, the FASB approved changes to the implementation date of this guidance for some filers. As a small reporting company, as defined by the SEC, our implementation date was delayed from January 1, 2020 to January 1, 2023. Early adoption continues to be permissible under the revised implementation date; currently we have no plans for early adoption. This guidance may have a significant impact on the results of 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 our implementation date. A committee was formed and is accountable for timely and accurate adoption of the guidance. A service provider that has focused on the ALLL for more than 10 years and serves hundreds of financial institutions has been engaged to provide us with education, advisory, and software solutions exclusively related to the ACL. We will run parallel processes which will help to ensure we are ready to calculate, review, and report the ACL by the required implementation date.
ASU No. 2018-14: “Compensation - Retirement Benefits - Defined Pension Plans - General (Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans”
In August 2018, ASU No. 2018-14 was issued and provided an updated framework related to defined benefit plans. For employers that sponsor defined benefit pension or other postretirement plans, the update provides disclosure modifications which include the removal of six specific requirements, the addition of two specific requirements and clarification to existing requirements.
Disclosure additions include 1) the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates; 2) an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. Clarification items relate to 1) the projected benefit obligation (PBO) and fair value of plan assets for plans with PBOs in excess of plan assets; and 2) the accumulated benefit obligation (ABO) and fair value of plan assets for plans with ABOs in excess of plan assets.
The new authoritative guidance is effective for fiscal years ending after December 15, 2020, with early adoption permitted, and will likely impact our financial statement disclosures.

11


Note 3 – AFS Securities
The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:
 March 31, 2020

Amortized
Cost
 Gross
Unrealized
Gains
 Gross
Unrealized
Losses
 Fair
Value
States and political subdivisions$159,267
 $3,849
 $
 $163,116
Auction rate money market preferred3,200
 
 474
 2,726
Mortgage-backed securities122,544
 4,010
 
 126,554
Collateralized mortgage obligations110,079
 4,714
 
 114,793
Total$395,090
 $12,573
 $474
 $407,189
 December 31, 2019

Amortized
Cost
 Gross
Unrealized
Gains
 Gross
Unrealized
Losses
 Fair
Value
States and political subdivisions$165,005
 $4,747
 $
 $169,752
Auction rate money market preferred3,200
 
 81
 3,119
Mortgage-backed securities139,831
 933
 560
 140,204
Collateralized mortgage obligations115,944
 1,007
 187
 116,764
Total$423,980
 $6,687
 $828
 $429,839
The amortized cost and fair value of AFS securities by contractual maturity at March 31, 2020 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
States and political subdivisions$27,544
 $69,886
 $38,580
 $23,257
 $
 $159,267
Auction rate money market preferred
 
 
 
 3,200
 3,200
Mortgage-backed securities
 
 
 
 122,544
 122,544
Collateralized mortgage obligations
 
 
 
 110,079
 110,079
Total amortized cost$27,544
 $69,886
 $38,580
 $23,257
 $235,823
 $395,090
Fair value$27,616
 $71,184
 $39,799
 $24,517
 $244,073
 $407,189
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 investments 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.
A summary of the sales activity of AFS securities was as follows for the three months ended March 31, 2020. There were no sales of AFS securities for the three months ended March 31, 2019.
 March 31
2020
Proceeds from sales of AFS securities$26,855
Realized gains (losses)$71
Applicable income tax expense (benefit)$15

12


The following information pertains to AFS securities with gross unrealized losses at March 31, 2020 and December 31, 2019, aggregated by investment category and length of time that individual securities have been in a continuous loss position. There were no AFS securities with gross unrealized losses in a continuous loss position less than twelve months at March 31, 2020.
 March 31, 2020
 Twelve Months or More

Gross
Unrealized
Losses
 Fair
Value
Auction rate money market preferred$474
 $2,726
Number of securities in an unrealized loss position:  2
 December 31, 2019
 Less Than Twelve Months Twelve Months or More  

Gross
Unrealized
Losses
 Fair
Value
 Gross
Unrealized
Losses
 Fair
Value
 Total
Unrealized
Losses
Auction rate money market preferred$
 $
 $81
 $3,119
 $81
Mortgage-backed securities3
 3,974
 557
 49,701
 560
Collateralized mortgage obligations43
 20,262
 144
 13,309
 187
Total$46
 $24,236
 $782
 $66,129
 $828
Number of securities in an unrealized loss position:  9
   19
 28
The reduction in unrealized losses on our AFS securities portfolio resulted from recent decreases in intermediate-term and long-term benchmark interest rates.
As of March 31, 2020 and December 31, 2019, we conducted an analysis to determine whether any AFS securities currently in an unrealized loss position should be identified as 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?
Based on our analysis, which included the criteria outlined above and the fact that we have asserted that we do not have to sell any AFS securities in an unrealized loss position, we do not believe that the values of any AFS securities are other-than-temporarily impaired as of March 31, 2020 or December 31, 2019, with the exception of one municipal bond previously identified which had no activity during the period.

13


Note 4 – 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, health care, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees. A portion of loans are unsecured.
Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and deferred fees or costs. Unless a loan has a nonaccrual status, 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 appropriate amortization method.
The accrual of interest on commercial and agricultural loans, as well as residential real estate loans, is discontinued at the time a loan is 90 days or more past due unless the credit is well-secured and in the process of short-term collection. Upon transferring a loan 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 a charge-off is necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on the contractual term of the loan. In all cases, a loan is placed in nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful.
When a loan is placed in 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 loans to 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 may be 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, property, or equipment. Government agency guarantee may be required. Personal guarantees and/or life insurance beneficiary assignments are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we may 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 consolidated balance sheets. Under the participation agreement, we committed to a maximum outstanding aggregate amount of $50,000. The difference between our outstanding balance and the maximum outstanding aggregate amount is classified as “Unfunded commitments under lines of credit” in the “Contractual Obligations and Loan Commitments” section of the Management's Discussion and Analysis of Financial Condition and Results of Operations of this report.
We offer adjustable rate mortgages, construction loans, and fixed rate residential real estate loans which have amortization periods up to a maximum of 30 years. We consider the anticipated direction of interest rates, balance sheet duration, the sensitivity of our balance sheet to changes in interest rates, our liquidity needs, 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.

14


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 are reviewed for appropriateness. Generally, mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market underwriting system; loans in excess of $1,000 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. Full or partial loan balances are charged against the ALLL when we believe uncollectability is probable. Subsequent recoveries, if any, are credited to the ALLL.
The ALLL is evaluated on a regular basis for appropriateness. Our periodic review of the collectability of a loan considers 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, or the fair value of the collateral, less costs to sell, if the loan is collateral dependent. 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 related to this portfolio. 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.
While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong at March 31, 2020. However, the COVID-19 pandemic has led to the temporary closure of businesses throughout the communities in which we serve, which has also led to increased unemployment. Therefore, we increased the ALLL during the quarter to account for inherent risk within the loan portfolio as of March 31, 2020. We continue to monitor the economic impact from COVID-19 as it relates to credit risk to ensure the ALLL is appropriate.
A summary of the ALLL and the recorded investment in loans by segments follows:
 Allowance for Loan Losses

Three Months Ended March 31, 2020

Commercial
Agricultural
Residential Real Estate
Consumer
Unallocated
Total
January 1, 2020$1,914

$634

$2,047

$922

$2,422

$7,939
Charge-offs(4)
(16)
(15)
(123)


(158)
Recoveries22

33

27

46



128
Provision for loan losses443

(161)
(342)
116

732

788
March 31, 2020$2,375

$490

$1,717

$961

$3,154

$8,697

15


 Allowance for Loan Losses and Recorded Investment in Loans
 March 31, 2020

Commercial Agricultural Residential Real Estate Consumer Unallocated Total
ALLL           
Individually evaluated for impairment$179
 $78
 $1,052
 $
 $
 $1,309
Collectively evaluated for impairment2,196
 412
 665
 961
 3,154
 7,388
Total$2,375
 $490
 $1,717
 $961
 $3,154
 $8,697
Loans           
Individually evaluated for impairment$8,598
 $13,660
 $5,374
 $3
   $27,635
Collectively evaluated for impairment686,680
 95,196
 296,642
 69,783
   1,148,301
Total$695,278
 $108,856
 $302,016
 $69,786
   $1,175,936
 Allowance for Loan Losses
 Three Months Ended March 31, 2019

Commercial Agricultural Residential Real Estate Consumer Unallocated Total
January 1, 2019$2,563
 $775
 $1,992
 $857
 $2,188
 $8,375
Charge-offs(8) 
 (2) (128) 
 (138)
Recoveries51
 1
 27
 48
 
 127
Provision for loan losses(358) (1) 288
 114
 (9) 34
March 31, 2019$2,248
 $775
 $2,305
 $891
 $2,179
 $8,398
 Allowance for Loan Losses and Recorded Investment in Loans
 December 31, 2019

Commercial Agricultural Residential Real Estate Consumer Unallocated Total
ALLL           
Individually evaluated for impairment$15
 $26
 $1,073
 $
 $
 $1,114
Collectively evaluated for impairment1,899
 608
 974
 922
 2,422
 6,825
Total$1,914
 $634
 $2,047
 $922
 $2,422
 $7,939
Loans           
Individually evaluated for impairment$7,865
 $14,840
 $5,486
 $
   $28,191
Collectively evaluated for impairment693,076
 102,080
 293,083
 70,140
   1,158,379
Total$700,941

$116,920
 $298,569
 $70,140
   $1,186,570

16


The following tables display the internally assigned credit risk ratings for commercial and agricultural credit exposures as of:
 March 31, 2020
 Commercial Agricultural  

Real Estate Other Advances to Mortgage Brokers Total Real Estate Other Total Total
Rating            
  
1 - Excellent$
 $10
 $
 $10
 $
 $
 $
 $10
2 - High quality4,326
 10,760
 
 15,086
 894
 13
 907
 15,993
3 - High satisfactory93,092
 43,940
 34,416
 171,448
 16,835
 4,976
 21,811
 193,259
4 - Low satisfactory381,334
 92,789
 
 474,123
 42,602
 19,671
 62,273
 536,396
5 - Special mention15,404
 3,530
 
 18,934
 5,601
 2,164
 7,765
 26,699
6 - Substandard7,177
 6,857
 
 14,034
 8,236
 3,258
 11,494
 25,528
7 - Vulnerable29
 1,339
 
 1,368
 2,839
 1,579
 4,418
 5,786
8 - Doubtful275
 
 
 275
 188
 
 188
 463
9 - Loss
 
 
 
 
 
 
 
Total$501,637
 $159,225
 $34,416
 $695,278
 $77,195
 $31,661
 $108,856
 $804,134
 December 31, 2019
 Commercial Agricultural  

Real Estate Other Advances to Mortgage Brokers Total Real Estate Other Total Total
Rating               
1 - Excellent$
 $390
 $
 $390
 $
 $
 $
 $390
2 - High quality2,582
 8,844
 
 11,426
 1,452
 99
 1,551
 12,977
3 - High satisfactory109,737
 42,858
 35,523
 188,118
 16,765
 6,769
 23,534
 211,652
4 - Low satisfactory377,198
 94,847
 
 472,045
 42,798
 20,861
 63,659
 535,704
5 - Special mention15,372
 3,470
 
 18,842
 7,165
 3,754
 10,919
 29,761
6 - Substandard4,874
 3,625
 
 8,499
 9,136
 3,836
 12,972
 21,471
7 - Vulnerable390
 1,231
 
 1,621
 2,711
 1,574
 4,285
 5,906
8 - Doubtful
 
 
 
 
 
 


9 - Loss
 
 
 
 
 
 
 
Total$510,153
 $155,265
 $35,523
 $700,941
 $80,027
 $36,893
 $116,920

$817,861
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.

17


2. HIGH QUALITY – Limited Risk
Credit with sound financial condition and a positive trend in earnings supplemented by:
Favorable liquidity and leverage ratios.
Ability to meet all obligations when due.
Management with successful track record.
Steady and satisfactory earnings history.
If loan is secured, collateral is of high quality and readily marketable.
Access to alternative financing.
Well defined primary and secondary source of repayment.
If supported by guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident.
3. HIGH SATISFACTORY – Reasonable Risk
Credit with satisfactory financial condition and further characterized by:
Working capital adequate to support operations.
Cash flow sufficient to pay debts as scheduled.
Management experience and depth appear favorable.
Loan performing according to terms.
If loan is secured, collateral is acceptable and loan is fully protected.
4. LOW SATISFACTORY – Acceptable Risk
Credit with bankable risks, although some signs of weaknesses are shown:
Would include most start-up businesses.
Occasional instances of trade slowness or repayment delinquency – may have been 10-30 days slow within the past year.
Management’s abilities are apparent yet unproven.
Weakness in primary source of repayment with adequate secondary source of repayment.
Loan structure generally in accordance with policy.
If secured, loan collateral coverage is marginal.
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 constitutes 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.
Loan may need to be restructured to improve collateral position or reduce payments.
Collateral or guaranty offers limited protection.
Negative debt service coverage, however the credit is well collateralized and payments are current.

18


6. SUBSTANDARD – Classified
Credit is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged. There is a distinct possibility we will implement collection procedures if the loan deficiencies are not corrected. Any commercial loan placed in nonaccrual status will be rated “7” or worse. 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.
Interest non-accrual may be warranted.
Collateral provides little or no value.
Requires excessive attention of the loan officer.
Borrower is uncooperative with loan officer.
7. VULNERABLE – Classified
Credit is considered “Substandard” and warrants placing in 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.
9. LOSS – Charge-off
Credit is considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification is for charged-off loans but does not mean that the asset has absolutely no recovery or salvage value. These loans are further characterized by:
Liquidation or reorganization under Bankruptcy, with poor prospects of collection.
Fraudulently overstated assets and/or earnings.
Collateral has marginal or no value.
Debtor cannot be located.
Over 120 days delinquent.

19


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 for the entire loan portfolio as of:
 March 31, 2020
 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$2,199
 $94
 $
 $304
 $2,597
 $499,040
 $501,637
Commercial other2,135
 109
 
 1,339
 3,583
 155,642
 159,225
Advances to mortgage brokers
 
 
 
 
 34,416
 34,416
Total commercial4,334
 203
 
 1,643
 6,180
 689,098
 695,278
Agricultural             
Agricultural real estate233
 
 
 3,027
 3,260
 73,935
 77,195
Agricultural other
 31
 
 1,579
 1,610
 30,051
 31,661
Total agricultural233
 31
 
 4,606
 4,870
 103,986
 108,856
Residential real estate             
Senior liens2,472
 77
 40
 576
 3,165
 258,959
 262,124
Junior liens35
 
 
 
 35
 5,509
 5,544
Home equity lines of credit141
 
 
 85
 226
 34,122
 34,348
Total residential real estate2,648
 77
 40
 661
 3,426
 298,590
 302,016
Consumer             
Secured356
 
 
 
 356
 66,105
 66,461
Unsecured7
 
 
 3
 10
 3,315
 3,325
Total consumer363
 
 
 3
 366
 69,420
 69,786
Total$7,578
 $311
 $40
 $6,913
 $14,842
 $1,161,094
 $1,175,936

20


 December 31, 2019
 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$139
 $30
 $
 $390
 $559
 $509,594
 $510,153
Commercial other531
 156
 
 1,231
 1,918
 153,347
 155,265
Advances to mortgage brokers
 
 
 
 
 35,523
 35,523
Total commercial670
 186
 
 1,621
 2,477
 698,464
 700,941
Agricultural             
Agricultural real estate
 
 
 2,711
 2,711
 77,316
 80,027
Agricultural other
 
 
 1,574
 1,574
 35,319
 36,893
Total agricultural
 
 
 4,285
 4,285
 112,635
 116,920
Residential real estate             
Senior liens3,463
 258
 
 557
 4,278
 253,894
 258,172
Junior liens65
 
 
 
 65
 5,766
 5,831
Home equity lines of credit157
 
 
 72
 229
 34,337
 34,566
Total residential real estate3,685
 258
 
 629
 4,572
 293,997
 298,569
Consumer             
Secured68
 
 
 
 68
 66,547
 66,615
Unsecured3
 
 
 
 3
 3,522
 3,525
Total consumer71
 
 
 
 71
 70,069
 70,140
Total$4,426
 $444
 $
 $6,535
 $11,405
 $1,175,165
 $1,186,570

21


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, or the fair value of the collateral, less costs to sell, if the loan is collateral dependent. Large groups of smaller-balance, homogeneous residential real estate and consumer loans are collectively evaluated for impairment 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.
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 impaired loans as of:
 March 31, 2020 December 31, 2019

Recorded Balance Unpaid Principal Balance Valuation Allowance Recorded Balance Unpaid Principal Balance Valuation Allowance
Impaired loans with a valuation allowance           
Commercial real estate$1,125
 $1,367
 $66
 $517
 $635
 $15
Commercial other919
 919
 113
 
 
 
Agricultural real estate2,247
 2,297
 70
 1,509
 1,509
 12
Agricultural other1,355
 1,355
 8
 1,355
 1,355
 14
Residential real estate senior liens5,285
 5,713
 1,052
 5,401
 5,830
 1,073
Total impaired loans with a valuation allowance10,931
 11,651
 1,309
 8,782
 9,329
 1,114
Impaired loans without a valuation allowance           
Commercial real estate4,162
 4,301
   4,961
 5,224
  
Commercial other2,392
 2,392
   2,387
 2,387
  
Agricultural real estate7,192
 7,192
   8,372
 8,422
  
Agricultural other2,866
 2,866
   3,604
 3,604
  
Home equity lines of credit89
 389
   85
 385
  
Consumer secured3
 3
   
 
  
Total impaired loans without a valuation allowance16,704
 17,143
   19,409
 20,022
  
Impaired loans           
Commercial8,598
 8,979
 179
 7,865
 8,246
 15
Agricultural13,660
 13,710
 78
 14,840
 14,890
 26
Residential real estate5,374
 6,102
 1,052
 5,486
 6,215
 1,073
Consumer3
 3
 
 
 
 
Total impaired loans$27,635
 $28,794
 $1,309
 $28,191
 $29,351
 $1,114

22


The following is a summary of impaired loans for the:
 Three Months Ended March 31
 2020 2019

Average Recorded Balance Interest Income Recognized Average Recorded Balance Interest Income Recognized
Impaired loans with a valuation allowance       
Commercial real estate$821
 $25
 $3,409
 $49
Commercial other460
 6
 12
 
Agricultural real estate1,878
 24
 390
 6
Agricultural other1,355
 22
 44
 
Residential real estate senior liens5,343
 55
 6,682
 68
Residential real estate junior liens
 
 12
 
Total impaired loans with a valuation allowance9,857
 132

10,549

123
Impaired loans without a valuation allowance       
Commercial real estate4,562
 59
 3,287
 53
Commercial other2,390
 15
 2,970
 21
Agricultural real estate7,782
 59
 7,623
 7
Agricultural other3,235
 7
 6,087
 70
Home equity lines of credit87
 6
 43
 6
Consumer secured2
 
 9
 
Total impaired loans without a valuation allowance18,058
 146
 20,019
 157
Impaired loans       
Commercial8,233
 105
 9,678
 123
Agricultural14,250
 112
 14,144
 83
Residential real estate5,430
 61
 6,737
 74
Consumer2
 
 9
 
Total impaired loans$27,915
 $278
 $30,568
 $280
As a result of line of credit agreements with borrowers, we had committed to advance $459 and $175 in additional funds to be disbursed in connection with impaired loans as of March 31, 2020 and December 31, 2019, respectively.
Troubled Debt Restructurings
A loan modification is considered to be a TDR 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 is not granted.
The borrower’s cash flow is insufficient to service all of their debt if the concession is 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


The following is a summary of TDRs granted for the:
 Three Months Ended March 31
 2020 2019

Number of Loans Pre-Modification Recorded Investment Post-Modification Recorded Investment Number of Loans Pre-Modification Recorded Investment Post-Modification Recorded Investment
Commercial other2
 $963
 $963
 1
 $147
 $147
Agricultural other2
 593
 593
 2
 523
 523
Residential real estate2
 93
 93
 
 
 
Total6
 $1,649
 $1,649
 3
 $670
 $670
The following is a summary of concessions we granted to borrowers in financial difficulty for the:

Three Months Ended March 31

2020 2019

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 other1
 $919
 1
 $44
 
 $
 1
 $147
Agricultural other
 
 2
 593
 
 
 2
 523
Residential real estate
 
 2
 93
 
 
 
 
Total1
 $919
 5
 $730
 
 $
 3
 $670
We did not restructure any loans by forgiving principal or accrued interest in the three-month periods ended March 31, 2020 or 2019.
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, 2020 and March 31, 2019 which were modified within 12 months prior to the default date.
The following is a summary of TDR loan balances as of:
 March 31
2020
 December 31
2019
TDRs$24,117
 $24,737
Measures we have taken to assist our customers in connection with the COVID-19 pandemic include loan programs that provide short-term payment relief.  Under these programs, borrowers who were in good standing as of March 1, 2020 can elect to defer full or partial payments for a 90-day period.  Bank regulators issued a statement on March 22, 2020, and a revised statement on April 7, 2020, which provides confirmation that short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers with a current payment status are not categorized as TDRs.

24


Note 5 – Borrowed Funds
Borrowed funds consist of the following obligations as of:
 March 31, 2020 December 31, 2019

Amount Rate Amount Rate
FHLB advances$235,000
 2.34% $245,000
 2.32%
Securities sold under agreements to repurchase without stated maturity dates28,171
 0.09% 30,999
 0.09%
Total$263,171
 2.10% $275,999
 2.07%
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, 2020 December 31, 2019

Amount Rate Amount Rate
Fixed rate due 2020$45,000
 2.28% $55,000
 2.18%
Fixed rate due 202150,000
 1.91% 50,000
 1.91%
Variable rate due 2021 (1)
10,000
 1.99% 10,000
 2.20%
Fixed rate due 202220,000
 1.97% 20,000
 1.97%
Fixed rate due 202345,000
 2.97% 45,000
 2.97%
Fixed rate due 202455,000
 2.68% 55,000
 2.68%
Fixed rate due 202610,000
 1.17% 10,000
 1.17%
Total$235,000
 2.34% $245,000
 2.32%
(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 $28,171 and $31,020 at March 31, 2020 and December 31, 2019, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.
Securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances generally mature within one to four days from the transaction date. We had no FRB Discount Window advances during the three-month periods ended March 31, 2020 and March 31, 2019. A summary of securities sold under repurchase agreements without stated maturity dates and federal funds purchased was as follows for the:
 Three Months Ended March 31
 2020 2019
 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$32,236
 $30,923
 0.10% $37,441
 $34,987
 0.10%
Federal funds purchased
 
 % 1,860
 458
 2.65%
We had pledged AFS securities and 1-4 family residential real estate loans in the following amounts at:

March 31
2020
 December 31
2019
Pledged to secure borrowed funds$364,985
 $368,310
Pledged to secure repurchase agreements28,171
 31,020
Pledged for public deposits and for other purposes necessary or required by law57,129
 59,537
Total$450,285
 $458,867

25


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

March 31
2020
 December 31
2019
States and political subdivisions$12,002
 $31,020
Mortgage-backed securities9,492
 
Collateralized mortgage obligations6,677
 
Total$28,171
 $31,020
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 an adequate level of AFS securities to pledge to satisfy required collateral.
As of March 31, 2020, we had the ability to borrow up to an additional $140,121, based on assets pledged as collateral. We had no investment securities that were restricted to be pledged for specific purposes.
Derivative Instruments
We use 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 have entered into LIBOR-based interest rate swaps that involve the receipt of variable amounts in exchange for fixed rate payments, in effect converting variable rate debt to fixed rate debt.
Cash flow hedges are assessed for effectiveness using regression analysis. The effective portion of changes in fair value are recorded in OCI and subsequently reclassified into interest expense in the same period in which the related interest on the variable rate borrowings affects earnings. In the event that a portion of the changes in fair value were determined to be ineffective, the ineffective amount would be recorded in earnings.
The following tables provide information on derivatives related to variable rate borrowings as of:
 March 31, 2020

Pay Rate Receive Rate Remaining Life (Years) Notional Amount Balance Sheet Location Fair Value
Derivatives designated as hedging instruments           
Cash Flow Hedges:           
Interest rate swaps1.56% 3-Month LIBOR 1.1 $10,000
 Other liabilities $(69)
 December 31, 2019
 Pay Rate Receive Rate Remaining Life (Years) Notional Amount Balance Sheet Location Fair Value
Derivatives designated as hedging instruments           
Cash Flow Hedges:           
Interest rate swaps1.56% 3-Month LIBOR 1.3 $10,000
 Other assets $67
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 the use of counterparty limits. We do not anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.

26


Note 6 – 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 includes 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.
Earnings per common share have been computed based on the following for the:
 Three Months Ended 
 March 31

2020 2019
Average number of common shares outstanding for basic calculation7,892,421
 7,888,885
Average potential effect of common shares in the Directors Plan (1)
163,186
 199,456
Average number of common shares outstanding used to calculate diluted earnings per common share8,055,607
 8,088,341
Net income$3,064
 $3,496
Earnings per common share   
Basic$0.39
 $0.44
Diluted$0.38
 $0.43
(1) 
Exclusive of shares held in the Rabbi Trust
Note 7 – Other Noninterest Expenses
A summary of expenses included in other noninterest expenses is as follows for the:

Three Months Ended 
 March 31
 2020 2019
Audit, consulting, and legal fees$433
 $453
Donations and community relations330
 140
ATM and debit card fees323
 248
Marketing costs203
 142
Memberships and subscriptions199
 167
Director fees182
 207
Loan underwriting fees166
 316
FDIC insurance premiums156
 170
Postage and freight131
 129
Education and travel91
 157
All other534
 525
Total other noninterest expenses$2,748
 $2,654

27


Note 8 – 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 is as follows for the:

Three Months Ended 
 March 31
 2020 2019
Income taxes at statutory rate$686
 $807
Effect of nontaxable income   
Interest income on tax exempt municipal securities(203) (244)
Earnings on corporate owned life insurance policies(148) (36)
Other(4) (4)
Total effect of nontaxable income(355) (284)
Effect of nondeductible expenses4
 6
Effect of tax credits(132) (180)
Federal income tax expense$203
 $349
Note 9 – Accumulated Other Comprehensive Income
The following table summarizes the changes in AOCI by component for the:
 Three Months Ended March 31
 2020 2019

Unrealized
Gains
(Losses) on
AFS
Securities
 Unrealized
Gains
(Losses) on Derivative Instruments
 Defined
Benefit
Pension Plan
 Total Unrealized
Gains
(Losses) on
AFS
Securities
 Unrealized
Gains
(Losses) on Derivative Instruments
 Defined
Benefit
Pension Plan
 Total
Balance, January 1$4,612
 $54
 $(2,695) $1,971
 $(5,200) $256
 $(2,741) $(7,685)
OCI before reclassifications6,311
 (136) 
 6,175
 5,954
 (81) 
 5,873
Amounts reclassified from AOCI(71) 
 
 (71) 
 
 
 
Subtotal6,240
 (136) 
 6,104
 5,954
 (81) 
 5,873
Tax effect(1,393) 28
 
 (1,365) (1,195) 17
 
 (1,178)
OCI, net of tax4,847
 (108) 
 4,739
 4,759

(64)


4,695
Balance,
March 31
$9,459
 $(54) $(2,695) $6,710
 $(441) $192
 $(2,741) $(2,990)
Included in OCI for the three-month periods ended March 31, 2020 and March 31, 2019 are changes in unrealized gains and losses related to auction rate money market preferred stocks. These investments, for federal income tax purposes, have no deferred federal income taxes related to unrealized gains or losses given the nature of the investments.

28


A summary of the components of unrealized gains on AFS securities included in OCI follows for the:
 Three Months Ended March 31
 2020 2019

Auction Rate Money Market Preferred Stocks All Other AFS Securities Total Auction Rate Money Market Preferred Stocks All Other AFS Securities Total
Unrealized gains (losses) arising during the period$(393) $6,704
 $6,311
 $265
 $5,689
 $5,954
Reclassification adjustment for net (gains) losses included in net income
 (71) (71) 
 
 
Net unrealized gains (losses)(393) 6,633
 6,240
 265
 5,689
 5,954
Tax effect
 (1,393) (1,393) 
 (1,195) (1,195)
Unrealized gains (losses), net of tax$(393) $5,240
 $4,847
 $265

$4,494

$4,759
Note 10 – 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.
Loans: We do not record loans at fair value on a recurring basis. However, some 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, 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.

29


We review the net realizable values of the underlying collateral for collateral dependent impaired loans on at least a quarterly basis for all loan types. To determine the collateral value, we utilize independent appraisals, broker price opinions, or internal evaluations. We review these valuations to determine whether an additional discount should be applied given the age of market information that may have been considered as well as other factors such as costs to sell an asset if it is determined that the collateral will be liquidated in connection with the ultimate settlement of the loan. We use these valuations to determine if any specific reserves or charge-offs are necessary. We may obtain new valuations in certain circumstances, including when there has been significant deterioration in the condition of the collateral, if the foreclosure process has begun, or if the existing valuation is deemed to be outdated.
The following tables list the quantitative fair value information about impaired loans as of:

March 31, 2020
Valuation TechniqueFair ValueUnobservable Input Actual RangeWeighted Average
  Discount applied to collateral:   
  Real Estate 20% - 30%23%
  Equipment 20% - 40%31%
Discounted value$18,778Cash crop inventory 40%40%
  Livestock 30%30%
  Other inventory 50%50%
  Accounts receivable 25% - 50%28%

December 31, 2019
Valuation TechniqueFair ValueUnobservable Input Actual RangeWeighted Average
  Discount applied to collateral:   
  Real Estate 20% - 30%22%
  Equipment 20% - 40%32%
Discounted value$19,135Cash crop inventory 40%40%
  Livestock 30%30%
  Other inventory 50%50%
  Accounts receivable 25% - 50%28%
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.
OMSR: OMSR (which are included in other assets) are subject to impairment testing. To test for impairment, we utilize a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and discount rates. If the valuation model reflects a value less than the carrying value, OMSR are adjusted to fair value through a valuation allowance as determined by the model. As such, we classify OMSR subject to nonrecurring fair value adjustments as Level 2.
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


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, 2020

Carrying
Value
 Estimated
Fair Value
 Level 1 Level 2 Level 3
ASSETS         
Cash and cash equivalents$96,751
 $96,751
 $96,751
 $
 $
Mortgage loans AFS1,228
 1,242
 
 1,242
 
Gross loans1,175,936
 1,172,598
 
 
 1,172,598
Less allowance for loan and lease losses8,697
 8,697
 
 
 8,697
Net loans1,167,239
 1,163,901
 
 
 1,163,901
Accrued interest receivable7,022
 7,022
 7,022
 
 
Equity securities without readily determinable fair values (1)
21,535
 N/A
 
 
 
OMSR2,003
 2,003
 
 2,003
 
LIABILITIES         
Deposits without stated maturities922,023
 922,023
 922,023
 
 
Deposits with stated maturities400,060
 406,330
 
 406,330
 
Borrowed funds263,171
 269,968
 
 269,968
 
Accrued interest payable845
 845
 845
 
 
 December 31, 2019
 Carrying
Value
 Estimated
Fair Value
 Level 1 Level 2 Level 3
ASSETS         
Cash and cash equivalents$60,572
 $60,572
 $60,572
 $
 $
Mortgage loans AFS904
 925
 
 925
 
Gross loans1,186,570
 1,170,370
 
 
 1,170,370
Less allowance for loan and lease losses7,939
 7,939
 
 
 7,939
Net loans1,178,631
 1,162,431
 
 
 1,162,431
Accrued interest receivable6,501
 6,501
 6,501
 
 
Equity securities without readily determinable fair values (1)
21,629
 N/A
 
 
 
OMSR2,264
 2,264
 
 2,264
 
LIABILITIES         
Deposits without stated maturities906,232
 906,232
 906,232
 
 
Deposits with stated maturities407,619
 409,600
 
 409,600
 
Borrowed funds275,999
 278,761
 
 278,761
 
Accrued interest payable860
 860
 860
 
 
(1) 
Due to the characteristics of equity securities without readily determinable fair values, they are not disclosed under a specific fair value hierarchy. When an impairment or write-down related to these securities is recorded, such amount would be classified as a nonrecurring Level 3 fair value adjustment.

31


Financial Instruments Recorded at Fair Value
The table below presents the recorded amount of assets and liabilities measured at fair value on:
 March 31, 2020 December 31, 2019

Total Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3
Recurring items               
AFS securities               
States and political subdivisions$163,116
 $
 $163,116
 $
 $169,752
 $
 $169,752
 $
Auction rate money market preferred2,726
 
 2,726
 
 3,119
 
 3,119
 
Mortgage-backed securities126,554
 
 126,554
 
 140,204
 
 140,204
 
Collateralized mortgage obligations114,793
 
 114,793
 
 116,764
 
 116,764
 
Total AFS securities407,189
 
 407,189
 
 429,839
 
 429,839
 
Derivative instruments69
 
 69
 
 67
 
 67
 
Nonrecurring items               
Impaired loans (net of the ALLL)18,778
 
 
 18,778
 19,135
 
 
 19,135
OMSR2,003
 
 2,003
 
 2,264
 
 2,264
 
Total$428,039
 $
 $409,261
 $18,778
 $451,305
 $
 $432,170
 $19,135
Percent of assets and liabilities measured at fair value  % 95.61% 4.39%   % 95.76% 4.24%
We recorded an impairment related to OMSR of $245 and $0 through earnings for the three months ended March 31, 2020 and March 31, 2019. We had no other assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a recurring basis or nonrecurring basis, as of March 31, 2020. Further, we had no unrealized gains and losses for the period included in OCI for recurring Level 3 fair value measurements held at the end of the reporting period.
Note 11 – Operating Segments
Our reportable segments are based on legal entities that account for at least 10% of net operating results. The Bank as of March 31, 2020 and December 31, 2019 and for the three-month periods ended March 31, 2020 and March 31, 2019, represent approximately 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented.

32


Note 12 – Parent Company Only Financial Information
Interim Condensed Balance Sheets

March 31
2020
 December 31
2019
ASSETS   
Cash on deposit at the Bank$216
 $1,360
Investments in subsidiaries163,889
 157,415
Premises and equipment1,528
 1,539
Other assets49,892
 49,887
TOTAL ASSETS$215,525
 $210,201
LIABILITIES AND SHAREHOLDERS’ EQUITY   
Other liabilities$27
 $19
Shareholders' equity215,498
 210,182
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY$215,525
 $210,201
Interim Condensed Statements of Income
 Three Months Ended 
 March 31

2020 2019
Income   
Dividends from subsidiaries$1,750
 $1,000
Interest income1
 2
Other income (loss)1
 (19)
Total income1,752
 983
Expenses   
Occupancy and equipment15
 15
Audit, consulting, and legal fees132
 130
Director fees94
 98
Other293
 290
Total expenses534
 533
Income before income tax benefit and equity in undistributed earnings of subsidiaries1,218
 450
Federal income tax benefit112
 115
Income before equity in undistributed earnings of subsidiaries1,330
 565
Undistributed earnings of subsidiaries1,734
 2,931
Net income$3,064
 $3,496

33


Interim Condensed Statements of Cash Flows
 Three Months Ended 
 March 31

2020 2019
Operating activities   
Net income$3,064
 $3,496
Adjustments to reconcile net income to cash provided by operations   
Undistributed earnings of subsidiaries(1,734) (2,931)
Undistributed earnings of equity securities without readily determinable fair values94
 57
Share-based payment awards under equity compensation plan123
 131
Depreciation11
 11
Changes in operating assets and liabilities which provided (used) cash   
Other assets(100) 26
Other liabilities8
 800
Net cash provided by (used in) operating activities1,466
 1,590
Investing activities - none
   
Financing activities   
Cash dividends paid on common stock(2,122) (2,043)
Proceeds from the issuance of common stock1,330
 1,433
Common stock repurchased(1,168) (632)
Common stock purchased for deferred compensation obligations(650) (186)
Net cash provided by (used in) financing activities(2,610) (1,428)
Increase (decrease) in cash and cash equivalents(1,144) 162
Cash and cash equivalents at beginning of period1,360
 2,499
Cash and cash equivalents at end of period$216
 $2,661

34


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)
The following is management's discussion and analysis of our financial condition and results of operations for the unaudited three-month periods ended March 31, 2020 and March 31, 2019. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2019 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, 2020, we reported net income of $3,064 and earnings per common share of $0.39. Net income and earnings per common share for the same period of 2019 were $3,496 and $0.44, respectively. A combination of reduced interest rates and loan volume were large drivers of a $280 decrease in interest income for the first three months of 2020 compared to the same period in 2019. Interest expense on deposits and borrowings decreased $93 for the three-month period ended March 31, 2020 compared to the same period in 2019 primarily due to reduced interest rates. Net interest income decreased by $187 for the three-month period ended March 31, 2020 in comparison to the same period in 2019. The provision for loan losses increased by $754 for the three-month period ended March 31, 2020 compared to the same period in 2019, as the result of increased economic and environmental risk factors, primarily driven by COVID-19, and an increase in impaired loan reserves. Noninterest income increased $508 during the first three months of 2020 compared to the same period in 2019, primarily as a result of a gain from the redemption of a corporate owned life insurance policy. Noninterest expenses for the first three months of 2020 modestly exceeded the same period in 2019 by $145, primarily due to compensation, community relations and donation-related expenses.
As of March 31, 2020, total assets and assets under management were $1,815,904 and $2,433,157, respectively. Assets under management include loans sold and serviced of $257,285 and investment and trust assets managed by Isabella Wealth of $359,968, in addition to assets on our consolidated balance sheet. In 2020, the Bank’s investment and trust services business was re-engineered and rebranded as Isabella Wealth to enhance the client experience, build scalability and expand market awareness.
Our securities portfolio has declined $22,650 since December 31, 2019, primarily as result of the sale of AFS securities. As a result of the flat yield curve that has existed for over a year, the opportunity to identify new investment securities for purchase at an acceptable yield has been minimal. Loans outstanding as of March 31, 2020 totaled $1,175,936. During the first three months of 2020, gross loans decreased $10,634 which was largely driven by a decline in our agricultural loan portfolio. Total deposits increased $8,232 during the first quarter of 2020, primarily due to increases in interest bearing demand and savings deposits, and totaled $1,322,083 as of March 31, 2020. 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 2.98% for the three months ended March 31, 2020. This compares to 3.02% for the three months ended March 31, 2019. Management has implemented various initiatives to improve our net yield on interest earning assets, which include enhanced pricing strategies related to loan and deposit products and a reduced reliance on borrowings and brokered deposits as funding sources. However, the current interest rate environment has had a negative impact on our net yields on interest earning assets and future improvement may be gradual. We are actively committed to increasing earnings and shareholder value through growth in our loan portfolio while maintaining strong underwriting standards, growth in our investment and trust services, increasing our presence within our geographical footprint, and managing operating costs.
Recent Events and Legislation
Unexpected and unprecedented changes have occurred during the quarter as the result of COVID-19.  COVID-19 is a new strain of coronavirus that spreads easily from person to person.  The aggressive and persistent virus causes a respiratory disease that currently has no approved vaccine or antiviral treatment and can result in serious illness or death.  The World Health Organization has declared the situation a global pandemic.
The pandemic has created significant market volatility, economic uncertainty, and disruption to normal business operations around the world, with slowdowns and shutdowns affecting entire industries.  The Michigan governor issued on March 23, 2020 a stay-at-home order, which limits gatherings and travel, and requires workers who are not necessary to sustain or protect life to stay home.  The Michigan stay-at-home order has since been extended to May 15.  The orders, as the result of COVID-19, have led to financial stress for many businesses and workers throughout the communities we serve.

35


The CARES Act, a massive and unprecedented federal government support program, was enacted on March 27, 2020.  It is a $2 trillion stimulus package intended to provide financial relief across the country.  The CARES Act includes the PPP, which enables small businesses to obtain a forgivable SBA loan to meet payroll, rent, utility, and mortgage interest obligations for the 8-week period following the loan origination, and re-open quickly once the public health crisis ends.  The first applications for PPP funds were accepted April 3, 2020.  We are proud to facilitate SBA PPP loans to businesses throughout the communities in which we serve.
Bank regulators issued an interim rule that neutralizes the regulatory capital effects by allowing a zero percent risk weight, for capital purposes, to loans originated under the PPP.  The capital rule was issued April 9, 2020, and is effective immediately.   
We have held discussions with many of our customers and they have expressed their general concern about the uncertain economic conditions, yet we believe it is premature to predict the magnitude of the impact at this point. Measures we have taken to assist our customers include loan programs that provide short-term payment relief.  Under these programs, borrowers who were in good standing as of March 1, 2020 can elect to defer full or partial payments for a 90-day period.  Bank regulators issued a statement on March 22, 2020, and a revised statement on April 7, 2020, which provides confirmation that short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers with a current payment status are not TDRs. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.
The extent to which COVID-19 impacts our business will depend on future developments, which are highly uncertain and cannot be predicted. Future developments include new information which may emerge concerning the severity of COVID-19 and the actions to contain the coronavirus or treat its impact, among others. We expect the significance of the COVID-19 pandemic, including the extent of its effect on our financial and operational results, to be dictated by, among other factors, its duration, the success of efforts to contain it and the impact of actions taken in response. Uncertainty created by the COVID-19 pandemic is pervasive, and the pandemic will likely impact our operations, customers, and various areas of risk; however, we are not able at this time to estimate the impact of the COVID-19 pandemic on our ongoing financial and operational results.
Reclassifications
Certain amounts reported in the interim 2019 consolidated financial statements have been reclassified to conform to the 2020 presentation.
Subsequent Events
We evaluated subsequent events after March 31, 2020 through the date the consolidated financial statements were issued for potential recognition and disclosure. Other than those noted in the Recent Events and Legislation section of this report, no subsequent events require financial statement recognition or disclosure between March 31, 2020 and the date the consolidated financial statements were issued.

36


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
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
INCOME STATEMENT DATA         
Interest income$16,201
 $16,849
 $17,161
 $16,815
 $16,481
Interest expense4,199
 4,492
 4,550
 4,527
 4,292
Net interest income12,002
 12,357
 12,611
 12,288
 12,189
Provision for loan losses788
 (18) 193
 (179) 34
Noninterest income2,998
 (725) 3,274
 3,011
 2,490
Noninterest expenses10,945
 10,892
 10,620
 10,749
 10,800
Federal income tax expense (benefit)203
 (140) 630
 541
 349
Net income$3,064
 $898
 $4,442
 $4,188
 $3,496
PER SHARE         
Basic earnings$0.39
 $0.12
 $0.56
 $0.53
 $0.44
Diluted earnings$0.38
 $0.11
 $0.55
 $0.52
 $0.43
Dividends$0.27
 $0.27
 $0.26
 $0.26
 $0.26
Tangible book value$21.10
 $20.45
 $20.66
 $20.17
 $19.47
Quoted market value         
High$24.50
 $24.80
 $23.45
 $23.75
 $24.50
Low$16.00
 $22.25
 $22.01
 $22.25
 $22.25
Close (1)
$18.00
 $24.31
 $22.30
 $23.25
 $23.75
Common shares outstanding (1)
7,921,291
 7,910,804
 7,938,234
 7,918,494
 7,906,078
PERFORMANCE RATIOS         
Return on average total assets0.68% 0.20% 0.98% 0.93% 0.77%
Return on average shareholders' equity5.68% 1.66% 8.37% 8.13% 7.00%
Return on average tangible shareholders' equity7.35% 2.18% 10.87% 10.67% 9.29%
Net interest margin yield (FTE)2.98% 3.06% 3.13% 3.06% 3.02%
BALANCE SHEET DATA (1)
         
Gross loans$1,175,936
 $1,186,570
 $1,191,804
 $1,176,622
 $1,144,832
AFS securities$407,189
 $429,839
 $445,529
 $470,449
 $494,842
Total assets$1,815,904
 $1,814,198
 $1,813,684
 $1,824,592
 $1,806,974
Deposits$1,322,083
 $1,313,851
 $1,308,773
 $1,281,418
 $1,277,963
Borrowed funds$263,171
 $275,999
 $277,386
 $320,462
 $311,684
Shareholders' equity$215,498
 $210,182
 $212,376
 $208,114
 $202,413
Gross loans to deposits88.95% 90.31% 91.06% 91.82% 89.58%
ASSETS UNDER MANAGEMENT (1)
         
Loans sold with servicing retained$257,285
 $259,375
 $258,873
 $257,062
 $259,127
Assets managed by Isabella Wealth$359,968
 $436,181
 $475,574
 $487,180
 $475,560
Total assets under management$2,433,157
 $2,509,754
 $2,548,131
 $2,568,834
 $2,541,661
ASSET QUALITY (1)
         
Nonperforming loans to gross loans0.59% 0.55% 0.59% 0.70% 0.64%
Nonperforming assets to total assets0.43% 0.40% 0.42% 0.49% 0.44%
ALLL to gross loans0.74% 0.67% 0.69% 0.68% 0.73%
CAPITAL RATIOS (1)
         
Shareholders' equity to assets11.87% 11.59% 11.71% 11.41% 11.20%
Tier 1 leverage9.09% 9.01% 9.16% 9.03% 8.91%
Common equity tier 1 capital12.72% 12.56% 12.58% 12.43% 12.45%
Tier 1 risk-based capital12.72% 12.56% 12.58% 12.43% 12.45%
Total risk-based capital13.41% 13.18% 13.21% 13.06% 13.12%
(1) At end of period

37


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
2020
 March 31
2019
 March 31
2018
INCOME STATEMENT DATA     
Interest income$16,201
 $16,481
 $15,121
Interest expense4,199
 4,292
 3,401
Net interest income12,002
 12,189
 11,720
Provision for loan losses788
 34
 384
Noninterest income2,998
 2,490
 2,487
Noninterest expenses10,945
 10,800
 10,096
Federal income tax expense (benefit)203
 349
 265
Net income$3,064
 $3,496

$3,462
PER SHARE     
Basic earnings$0.39
 $0.44
 $0.44
Diluted earnings$0.38
 $0.43
 $0.43
Dividends$0.27
 $0.26
 $0.26
Tangible book value$21.10
 $19.47
 $19.16
Quoted market value     
High$24.50
 $24.50
 $28.25
Low$16.00
 $22.25
 $26.11
Close (1)
$18.00
 $23.75
 $27.40
Common shares outstanding (1)
7,921,291
 7,906,078
 7,894,341
PERFORMANCE RATIOS     
Return on average total assets0.68% 0.77% 0.77%
Return on average shareholders' equity5.68% 7.00% 7.11%
Return on average tangible shareholders' equity1.84% 9.29% 9.23%
Net interest margin yield (FTE)2.98% 3.02% 2.95%
BALANCE SHEET DATA (1)
     
Gross loans$1,175,936
 $1,144,832
 $1,093,002
AFS securities$407,189
 $494,842
 $547,762
Total assets$1,815,904
 $1,806,974
 $1,799,592
Deposits$1,322,083
 $1,277,963
 $1,297,868
Borrowed funds$263,171
 $311,684
 $303,113
Shareholders' equity$215,498
 $202,413
 $191,090
Gross loans to deposits88.95% 89.58% 84.22%
ASSETS UNDER MANAGEMENT (1)
     
Loans sold with servicing retained$257,285
 $259,127
 $262,541
Assets managed by Isabella Wealth$359,968
 $475,560
 $470,578
Total assets under management$2,433,157
 $2,541,661
 $2,532,711
ASSET QUALITY (1)
     
Nonperforming loans to gross loans0.59% 0.64% 0.63%
Nonperforming assets to total assets0.43% 0.44% 0.41%
ALLL to gross loans0.74% 0.73% 0.75%
CAPITAL RATIOS (1)
     
Shareholders' equity to assets11.87% 11.20% 10.62%
Tier 1 leverage9.09% 8.91% 8.69%
Common equity tier 1 capital12.72% 12.45% 12.34%
Tier 1 risk-based capital12.72% 12.45% 12.34%
Total risk-based capital13.41% 13.12% 13.01%
(1) At end of period

38


Average Balances, Interest Rates, 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%. 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 other interest earning assets.

Three Months Ended

March 31, 2020
December 31, 2019
March 31, 2019

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$1,168,070

$13,254

4.54%
$1,184,449

$13,694

4.62%
$1,131,093

$12,891

4.56%
Taxable investment securities251,797

1,489

2.37%
269,691

1,663

2.47%
319,962

1,958

2.45%
Nontaxable investment securities152,368

1,418

3.72%
160,022

1,513

3.78%
179,887

1,687

3.75%
Fed funds sold
 
 % 11
 
 1.46% 26
 
 %
Other90,297

405

1.79%
55,471

375

2.70%
40,809

379

3.71%
Total earning assets1,662,532

16,566

3.99%
1,669,644

17,245

4.13%
1,671,777

16,915

4.05%
NONEARNING ASSETS
















Allowance for loan losses(7,968)




(8,205)




(8,406)



Cash and demand deposits due from banks21,556





20,838





19,194




Premises and equipment26,252





26,377





27,710




Accrued income and other assets110,786





113,383





99,758




Total assets$1,813,158





$1,822,037





$1,810,033




INTEREST BEARING LIABILITIES
















Interest bearing demand deposits$235,161

$83

0.14%
$221,924

$78

0.14%
$236,074

$68

0.12%
Savings deposits426,634

634

0.59%
417,623

727

0.70%
381,134

615

0.65%
Time deposits404,717

2,074

2.05%
423,177

2,240

2.12%
436,448

2,035

1.87%
Borrowed funds270,648

1,408

2.08%
276,574

1,447

2.09%
321,445

1,574

1.96%
Total interest bearing liabilities1,337,160

4,199

1.26%
1,339,298

4,492

1.34%
1,375,101

4,292

1.25%
NONINTEREST BEARING LIABILITIES
















Demand deposits246,262





251,596





226,425




Other14,130





15,359





8,878




Shareholders’ equity215,606





215,784





199,629




Total liabilities and shareholders’ equity$1,813,158





$1,822,037





$1,810,033




Net interest income (FTE)

$12,367





$12,753





$12,623


Net yield on interest earning assets (FTE)



2.98%




3.06%




3.02%
Net interest income is the amount by which interest income on earning assets exceeds the interest expense on interest bearing liabilities. Net interest income is influenced by changes in the balance and mix of assets and liabilities, as well as 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 including the income tax savings from interest on tax exempt loans and nontaxable investment securities, thus making year to year comparisons more meaningful.

39


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. 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, 2020 Compared to 
 December 31, 2019 
 Increase (Decrease) Due to
 Three Months Ended 
 March 31, 2020 Compared to  
 March 31, 2019 
  Increase (Decrease) Due to

Volume Rate Net Volume Rate Net
Changes in interest income           
Loans$(188) $(252) $(440) $420
 $(57) $363
Taxable investment securities(108) (66) (174) (405) (64) (469)
Nontaxable investment securities(72) (23) (95) (256) (13) (269)
Other184
 (154) 30
 293
 (267) 26
Total changes in interest income(184) (495) (679) 52
 (401) (349)
Changes in interest expense           
Interest bearing demand deposits5
 
 5
 
 15
 15
Savings deposits15
 (108) (93) 70
 (51) 19
Time deposits(96) (70) (166) (154) 193
 39
Borrowed funds(31) (8) (39) (260) 94
 (166)
Total changes in interest expense(107) (186) (293) (344) 251
 (93)
Net change in interest margin (FTE)$(77) $(309) $(386) $396
 $(652) $(256)
The flattening of the yield curve and recent rate reductions placed pressure on our net interest margin, and we experienced a decline in our net yield on interest earning assets. Given the uncertainty in rates and the economic environment as a result of COVID-19, improvement in our net yield on interest earning assets may not occur during the remainder of 2020.
 Average Yield / Rate for the Three-Month Periods Ended:

March 31
2020

December 31
2019

September 30
2019

June 30
2019

March 31
2019
Total earning assets3.99% 4.13% 4.23% 4.15% 4.05%
Total interest bearing liabilities1.26% 1.34% 1.35% 1.33% 1.25%
Net yield on interest earning assets (FTE)2.98%
3.06% 3.13% 3.06% 3.02%
 Quarter to Date Net Interest Income (FTE)

March 31
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
Total interest income (FTE)$16,566
 $17,245
 $17,567
 $17,231
 $16,915
Total interest expense4,199
 4,492
 4,550
 4,527
 4,292
Net interest income (FTE)$12,367
 $12,753
 $13,017
 $12,704
 $12,623

40


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 reflect 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, provision for loan losses, and ALLL balances as of, and for the:
 Three Months Ended 
 March 31

2020 2019
ALLL at beginning of period$7,939
 $8,375
Charge-offs   
Commercial4
 8
Agricultural16
 
Residential real estate15
 2
Consumer123
 128
Total charge-offs158
 138
Recoveries   
Commercial22
 51
Agricultural33
 1
Residential real estate27
 27
Consumer46
 48
Total recoveries128
 127
Net loan charge-offs (recoveries)30
 11
Provision for loan losses788
 34
ALLL at end of period$8,697
 $8,398
Net loan charge-offs (recoveries) to average loans outstanding% %
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
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
Total charge-offs$158
 $334
 $143
 $333
 $138
Total recoveries128
 122
 82
 151
 127
Net loan charge-offs (recoveries)30
 212
 61
 182
 11
Net loan charge-offs (recoveries) to average loans outstanding% 0.02 % 0.01% 0.02 % %
Provision for loan losses$788
 $(18) $193
 $(179) $34
Provision for loan losses to average loans outstanding0.07%  % 0.02% (0.02)% %
ALLL$8,697
 $7,939
 $8,169
 $8,037
 $8,398
ALLL as a % of loans at end of period0.74% 0.67 % 0.69% 0.68 % 0.73%
While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong at March 31, 2020. However, the COVID-19 pandemic has led to the temporary closure of businesses throughout the communities in which we serve, which has also led to increased unemployment. We increased the ALLL during the quarter as a result of increased economic and environmental risk factors, primarily driven by COVID-19. The economic impact from the COVID-19 crisis could pose significant credit risk due to the potential inability of consumer and commercial borrowers to make contractual payments. In late March 2020, we implemented payment programs for borrowers to alleviate the financial

41


setback due to the temporary closure of businesses and lost wages. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators. We continue to monitor the economic impact from COVID-19 as it relates to credit risk to ensure the ALLL is appropriate.
The following table illustrates the two main components of the ALLL as of:

March 31
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
ALLL         
Individually evaluated for impairment$1,309
 $1,114
 $1,333
 $1,479
 $1,509
Collectively evaluated for impairment7,388
 6,825
 6,836
 6,558
 6,889
Total$8,697
 $7,939
 $8,169
 $8,037
 $8,398
ALLL to gross loans         
Individually evaluated for impairment0.11% 0.09% 0.11% 0.13% 0.13%
Collectively evaluated for impairment0.63% 0.58% 0.58% 0.55% 0.60%
Total0.74% 0.67% 0.69% 0.68% 0.73%
The level of the ALLL is appropriate as of March 31, 2020. We 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 an appropriate level.
For further discussion of the allocation of the ALLL, see “Note 4 – 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 for indications of additional deterioration.
 Total Past Due and Nonaccrual Loans

March 31
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
Commercial$6,180
 $2,477
 $3,175
 $2,243
 $5,299
Agricultural4,870
 4,285
 4,800
 6,672
 6,854
Residential real estate3,426
 4,572
 1,999
 1,690
 6,063
Consumer366
 71
 162
 94
 152
Total$14,842
 $11,405
 $10,136
 $10,699
 $18,368
Total past due and nonaccrual loans to gross loans1.26% 0.96% 0.85% 0.91% 1.60%
Past due and nonaccrual status loans increased in 2020 primarily as a result of deterioration in credit quality for a small number of commercial loans. The increase did not result from the economic impact of COVID-19 or any other apparent factor. As such, we do not believe this activity to be indicative of a trend in past due levels.
We have implemented payment programs for borrowers to alleviate the financial setback due to the temporary closure of businesses and lost wages. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.
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 4 – Loans and ALLL” of our interim condensed consolidated financial statements.

42


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 collectible. This approach has permitted certain borrowers to accept a payment structure that will allow them to continue making payments in lieu of foreclosure. The modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. The majority of modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed in 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 grant a combination of these modifications. Typically, the modifications are for a period of three years or less. There were no TDRs that were government sponsored as of March 31, 2020 or December 31, 2019.
Losses associated with TDRs, if any, are included in the estimation of the ALLL during the quarter in which a loan is identified as a TDR, and we review the analysis of the ALLL estimation each reporting period thereafter to ensure its continued appropriateness.
The following tables provide roll-forwards of TDRs for the:

Three Months Ended March 31, 2020
 Accruing Interest Nonaccrual Total
 Number
of
Loans
 Balance Number
of
Loans
 Balance Number
of
Loans
 Balance
January 1, 2020122
 $21,194
 9
 $3,543
 131
 $24,737
New modifications5
 1,156
 1
 493
 6
 1,649
Principal advances (payments)
 (984) 
 (106) 
 (1,090)
Loans paid off(13) (1,098) 
 
 (13) (1,098)
Transfers to OREO
 
 (1) (81) (1) (81)
March 31, 2020114
 $20,268
 9
 $3,849
 123
 $24,117

Three Months Ended March 31, 2019
 Accruing Interest Nonaccrual Total
 Number
of
Loans
 Balance Number
of
Loans
 Balance Number
of
Loans
 Balance
January 1, 2019133
 $23,400
 28
 $3,551
 161
 $26,951
New modifications3
 670
 
 
 3
 670
Principal advances (payments)
 (340) 
 (127) 
 (467)
Loans paid off(6) (799) (3) (177) (9) (976)
Transfers to OREO
 
 (1) (48) (1) (48)
Transfers to nonaccrual status(2) (626) 2
 626
 
 
March 31, 2019128
 $22,305
 26
 $3,825
 154
 $26,130
The following table summarizes our TDRs as of:
 March 31, 2020 December 31, 2019  

Accruing
Interest
 Nonaccrual Total Accruing
Interest
 Nonaccrual Total Total
Change
Current$19,842
 $493
 $20,335
 $20,847
 $507
 $21,354
 $(1,019)
Past due 30-59 days386
 104
 490
 346
 
 346
 144
Past due 60-89 days
 
 
 1
 
 1
 (1)
Past due 90 days or more40
 3,252
 3,292
 
 3,036
 3,036
 256
Total$20,268
 $3,849
 $24,117
 $21,194
 $3,543
 $24,737
 $(620)
Additional disclosures about TDRs are included in “Note 4 – Loans and ALLL” of our interim condensed consolidated financial statements.

43


Impaired Loans
The following is a summary of information pertaining to impaired loans as of:
 March 31, 2020 December 31, 2019

Recorded
Balance
 Unpaid
Principal
Balance
 Valuation
Allowance
 Recorded
Balance
 Unpaid
Principal
Balance
 Valuation
Allowance
TDRs           
Commercial real estate$5,136
 $5,455
 $66
 $5,325
 $5,643
 $15
Commercial other1,972
 1,972
 113
 1,156
 1,156
 
Agricultural real estate8,816
 8,816
 67
 9,182
 9,181
 12
Agricultural other3,679
 3,679
 8
 4,421
 4,421
 14
Residential real estate senior liens4,510
 4,792
 898
 4,641
 4,923
 922
Home equity lines of credit4
 304
 
 12
 312
 
Total TDRs24,117
 25,018
 1,152
 24,737
 25,636
 963
Other impaired loans           
Commercial real estate151
 213
 
 153
 216
 
Commercial other1,339
 1,339
 
 1,231
 1,231
 
Agricultural real estate623
 673
 3
 699
 750
 
Agricultural other542
 542
 
 538
 538
 
Residential real estate senior liens775
 921
 154
 760
 907
 151
Home equity lines of credit85
 85
 
 73
 73
 
Consumer secured3
 3
 
 
 
 
Total other impaired loans3,518
 3,776
 157
 3,454
 3,715
 151
Total impaired loans$27,635
 $28,794
 $1,309
 $28,191
 $29,351
 $1,114
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 recognition of a charge-off.
We have implemented payment programs for borrowers to alleviate the financial setback due to the temporary closure of businesses and lost wages. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.

Additional disclosures related to impaired loans are included in “Note 4 – Loans and ALLL” of our interim condensed consolidated financial statements.

44


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

March 31
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
Nonaccrual status loans$6,913
 $6,535
 $6,962
 $8,107
 $7,260
Accruing loans past due 90 days or more40
 
 40
 110
 30
Total nonperforming loans6,953
 6,535
 7,002
 8,217
 7,290
Foreclosed assets564
 456
 468
 513
 401
Debt securities230
 230
 230
 230
 230
Total nonperforming assets$7,747
 $7,221
 $7,700
 $8,960
 $7,921
Nonperforming loans as a % of total loans0.59% 0.55% 0.59% 0.70% 0.64%
Nonperforming assets as a % of total assets0.43% 0.40% 0.42% 0.49% 0.44%
The accrual of interest on commercial and agricultural loans, as well as residential real estate loans, is discontinued at the time a loan is 90 days or more past due unless the credit is well-secured and in the process of short-term collection. Upon transferring a loan 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 a charge-off is necessary. Consumer loans are typically charged-off no later than 180 days past due. 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 fluctuated in recent periods, it remains low in comparison to peer banks. Recent fluctuations in nonaccrual loans have been concentrated in our agricultural portfolio as a result of the challenges facing much of the agricultural industry.
The following table summarizes nonaccrual loans as of:

March 31
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
Commercial$1,643
 $1,621
 $1,632
 $1,692
 $1,931
Agricultural4,606
 4,285
 4,520
 5,532
 4,757
Residential real estate661
 629
 810
 883
 572
Consumer3
 
 
 
 
Total$6,913
 $6,535
 $6,962
 $8,107
 $7,260
Included in the nonaccrual loan balances above were loans currently classified as TDR as of:

March 31
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
Commercial$304
 $390
 $390
 $450
 $515
Agricultural3,441
 3,048
 3,309
 5,096
 3,199
Residential real estate104
 105
 107
 109
 111
Total$3,849
 $3,543
 $3,806
 $5,655
 $3,825
We have implemented payment programs for borrowers to alleviate the financial setback due to the temporary closure of businesses and lost wages. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.
Additional disclosures about nonaccrual status loans are included in “Note 4 – Loans and ALLL” of our interim condensed consolidated financial statements.

45


Noninterest Income and Noninterest Expenses
Significant noninterest income balances are highlighted in the following tables for the:

Three Months Ended March 31
     Change
 2020 2019 $ %
Service charges and fees       
ATM and debit card fees$794
 $685
 $109
 15.91 %
Service charges and fees on deposit accounts587
 530
 57
 10.75 %
Freddie Mac servicing fee159
 150
 9
 6.00 %
Net OMSR income (loss)(261) 12
 (273) N/M
Other fees for customer services74
 84
 (10) (11.90)%
Total service charges and fees1,353
 1,461
 (108) (7.39)%
Investment and trust advisory fees572
 677
 (105) (15.51)%
Gains from redemption of corporate owned life insurance policies524
 
 524
 N/M
Earnings on corporate owned life insurance policies182
 184
 (2) (1.09)%
Net gain on sale of mortgage loans151
 93
 58
 62.37 %
Other       
Net gains on sale of AFS securities71
 
 71
 N/M
All other145
 75
 70
 93.33 %
Total other216
 75
 141
 188.00 %
Total noninterest income$2,998
 $2,490
 $508
 20.40 %
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 structure, we do expect that fee income will continue to increase during the remainder of 2020 as the usage of ATM and debit cards continues to increase.
OMSR income results are driven, in part, by changes in offering rates on residential mortgage loans, anticipated prepayments in the servicing-retained portfolio, and the volume of loans within the servicing-retained portfolio. Increased prepayment speeds, as a result of a decline in interest rates, were the primary driver of the losses recognized during the first quarter. Income during 2020 could experience fluctuations and could vary from 2019 levels.
The decrease in investment and trust advisory fees was driven by a reduction in trust-related assets, which resulted significantly from a decline in the stock market during the first quarter of 2020. With the uncertainty in the stock market as a result of COVID-19, investment and trust advisory fees during the remainder of 2020 may not exceed 2019 levels.
We recognized a gain during the first quarter of 2020 due to the redemption of a corporate owned life insurance policy in connection with the passing of a retired executive officer.
Net gain on sale of mortgage loans fluctuates primarily as the result of a change in the amount of loans sold. The amount of loans sold can fluctuate based on balance sheet management strategies. As such, net gain on sale of mortgage loans will continue to fluctuate in comparison to 2019 during the remainder of 2020.
We are continually analyzing our AFS securities portfolio for potential sale opportunities. Securities with unrealized gains or less than desirable yields may be sold for funding and profitability purposes. During the first quarter of 2020, we identified $26,855 in securities that were desirable to be sold and recognized net gains of $71 with these sales. We anticipate taking this same approach of analyzing our AFS securities portfolio for potential sale opportunities during the remainder of 2020.
The fluctuations in all other income are spread throughout various categories, none of which are individually significant.

46


Significant noninterest expense balances are highlighted in the following tables for the:

Three Months Ended March 31
     Change
 2020 2019 $ %
Compensation and benefits$5,869

$5,722
 $147
 2.57 %
Furniture and equipment1,461

1,494
 (33) (2.21)%
Occupancy867

930
 (63) (6.77)%
Other       
Audit, consulting, and legal fees433
 453
 (20) (4.42)%
Donations and community relations330
 140
 190
 135.71 %
ATM and debit card fees323
 248
 75
 30.24 %
Marketing costs203
 142
 61
 42.96 %
Memberships and subscriptions199
 167
 32
 19.16 %
Director fees182
 207
 (25) (12.08)%
Loan underwriting fees166
 316
 (150) (47.47)%
FDIC insurance premiums156
 170
 (14) (8.24)%
Postage and freight131
 129
 2
 1.55 %
Education and travel91
 157
 (66) (42.04)%
All other534
 525
 9
 1.71 %
Total other noninterest expenses2,748
 2,654
 94
 3.54 %
Total noninterest expenses$10,945
 $10,800
 $145
 1.34 %
Donations and community relations increased during 2020 as a result of initiatives designed to deepen and strengthen our relationship with the communities in which we operate and serve which includes an expanded footprint. In addition to providing monetary contributions, some of these initiatives include volunteering our time, which is not a component of donations and community relations costs. While these discretionary contributions incurred in 2020 resulted in increased expenses, donations and community relations during the remainder of 2020 are not expected to exceed 2019 levels.
Loan underwriting fees were higher during the first quarter of 2019 as a result of new loan products, including first time home buyer and down payment assistance programs, that are no longer offered. Loan underwriting fees during 2020 are not expected to exceed 2019 levels.
Education and travel expenses fluctuate based on the timing of trainings and seminars. Beginning in mid-March of 2020, travel declined due to COVID-19 and recommendations by the Center for Disease Control to limit in-person gatherings. With the recent stay-at-home order in the State of Michigan due to COVID-19, education and travel expenses during the remainder of 2020 may decline in comparison to 2019 levels.
The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.

47


Analysis of Changes in Financial Condition

March 31
2020
 December 31
2019
 $ Change % Change
(unannualized)
ASSETS       
Cash and cash equivalents$96,751
 $60,572
 $36,179
 59.73 %
AFS securities       
Amortized cost of AFS securities395,090
 423,980
 (28,890) (6.81)%
Unrealized gains (losses) on AFS securities12,099
 5,859
 6,240
 106.50 %
AFS securities407,189
 429,839
 (22,650) (5.27)%
Mortgage loans AFS1,228
 904
 324
 35.84 %
Loans    

  
Gross loans1,175,936
 1,186,570
 (10,634) (0.90)%
Less allowance for loan and lease losses8,697
 7,939
 758
 9.55 %
Net loans1,167,239
 1,178,631
 (11,392) (0.97)%
Premises and equipment25,946
 26,242
 (296) (1.13)%
Corporate owned life insurance policies27,691
 28,455
 (764) (2.68)%
Accrued interest receivable7,022
 6,501
 521
 8.01 %
Equity securities without readily determinable fair values21,535
 21,629
 (94) (0.43)%
Goodwill and other intangible assets48,366
 48,379
 (13) (0.03)%
Other assets12,937
 13,046
 (109) (0.84)%
TOTAL ASSETS$1,815,904
 $1,814,198
 $1,706
 0.09 %
LIABILITIES AND SHAREHOLDERS’ EQUITY       
Liabilities       
Deposits$1,322,083
 $1,313,851
 $8,232
 0.63 %
Borrowed funds263,171
 275,999
 (12,828) (4.65)%
Accrued interest payable and other liabilities15,152
 14,166
 986
 6.96 %
Total liabilities1,600,406
 1,604,016
 (3,610) (0.23)%
Shareholders’ equity215,498
 210,182
 5,316
 2.53 %
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY$1,815,904
 $1,814,198
 $1,706
 0.09 %
As shown above, total assets were relatively unchanged from December 31, 2019. Cash and cash equivalents increased as a result of the sale of AFS securities and an increase in customer deposits during the first quarter of 2020. We experienced a $10,634 decrease in loans during the first three months of 2020 which was largely driven by a decline in our agricultural loan portfolio.
The following table outlines the changes in loan balances:

March 31
2020
 December 31
2019
 $ Change % Change
(unannualized)
Commercial$695,278
 $700,941
 $(5,663) (0.81)%
Agricultural108,856
 116,920
 (8,064) (6.90)%
Residential real estate302,016
 298,569
 3,447
 1.15 %
Consumer69,786
 70,140
 (354) (0.50)%
Total$1,175,936
 $1,186,570
 $(10,634) (0.90)%

48


The following table displays loan balances as of:

March 31
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
Commercial$695,278
 $700,941
 $708,735
 $701,954
 $677,554
Agricultural108,856
 116,920
 118,460
 120,363
 123,393
Residential real estate302,016
 298,569
 292,311
 283,285
 276,776
Consumer69,786
 70,140
 72,298
 71,020
 67,109
Total$1,175,936
 $1,186,570
 $1,191,804
 $1,176,622
 $1,144,832
The competition for commercial loan opportunities continues to be strong in the current interest rate environment. While we experienced a decline in this segment of the portfolio during the first quarter, we expect growth in the commercial loan portfolio during the remainder of 2020 due to our participation in the SBA PPP, in addition to continuing to provide attractive and competitive loan products. During the first quarter of 2020, and over the past 12 months, agricultural loans have declined. Residential real estate and consumer loans experienced growth over the past year and continued growth is expected during the remainder of 2020.
The following table outlines the changes in deposit balances:

March 31
2020
 December 31
2019
 $ Change % Change
(unannualized)
Noninterest bearing demand deposits$249,424
 $249,152
 $272
 0.11 %
Interest bearing demand deposits237,392
 229,865
 7,527
 3.27 %
Savings deposits435,207
 427,215
 7,992
 1.87 %
Certificates of deposit358,534
 365,049
 (6,515) (1.78)%
Brokered certificates of deposit27,458
 27,458
 
  %
Internet certificates of deposit14,068
 15,112
 (1,044) (6.91)%
Total$1,322,083
 $1,313,851
 $8,232
 0.63 %
The following table displays deposit balances as of:

March 31
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
Noninterest bearing demand deposits$249,424
 $249,152
 $242,179
 $244,240
 $229,865
Interest bearing demand deposits237,392
 229,865
 230,579
 228,704
 236,997
Savings deposits435,207
 427,215
 409,930
 378,988
 385,617
Certificates of deposit358,534
 365,049
 357,984
 359,945
 361,716
Brokered certificates of deposit27,458
 27,458
 52,744
 57,773
 50,273
Internet certificates of deposit14,068
 15,112
 15,357
 11,768
 13,495
Total$1,322,083
 $1,313,851
 $1,308,773
 $1,281,418
 $1,277,963
Total deposits have steadily increased over the past 12 months with significant growth in non-contractual deposits, such as noninterest bearing demand and savings deposits. This trend is anticipated to continue during the remainder of 2020 as the financial markets continue to exhibit significant signs of instability. We experienced fluctuations in certificates of deposit over the past year while brokered certificates of deposit have significantly declined. Brokered certificates of deposit offer another source of funding and may fluctuate from period to period based on our funding needs, including changes in assets such as loans and investments. During 2019, we used excess funds to reduce higher-cost deposits, such as brokered certificates of deposit.

49


The primary objective of our investing activities is to provide for safety of the principal invested. Secondary considerations include providing earnings and liquidity while managing our overall exposure to changes in interest rates. The current flat yield curve encourages using excess funds to reduce higher-cost borrowings and therefore, AFS securities balances are not expected to rise significantly in the near term as a result of the current interest rate environment. The following table displays fair values of AFS securities as of:

March 31
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
Government sponsored enterprises$
 $
 $
 $160
 $165
States and political subdivisions163,116
 169,752
 175,575
 176,742
 191,266
Auction rate money market preferred2,726
 3,119
 3,089
 2,849
 2,819
Mortgage-backed securities126,554
 140,204
 150,120
 173,340
 181,138
Collateralized mortgage obligations114,793
 116,764
 116,745
 117,358
 119,454
Total$407,189
 $429,839
 $445,529
 $470,449
 $494,842
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 that arise from changes in loans, investments, and deposits. To provide balance sheet growth, we may utilize borrowings and brokered deposits to fund earning assets. The following table displays borrowed funds balances as of:

March 31
2020
 December 31
2019
 September 30
2019
 June 30
2019
 March 31
2019
FHLB advances$235,000
 $245,000
 $245,000
 $295,000
 $280,000
Securities sold under agreements to repurchase without stated maturity dates28,171
 30,999
 32,386
 25,462
 29,824
Federal funds purchased
 
 
 
 1,860
Total$263,171
 $275,999
 $277,386
 $320,462
 $311,684
Contractual Obligations and Loan Commitments
We have various financial obligations, including contractual obligations and commitments related to deposits and borrowings, which may require future cash payments. We also have loan related commitments that may impact liquidity. The commitments include unused lines of credit, commercial and standby letters of credit, and commitments to grant loans. These commitments to grant loans include residential mortgage loans with the majority committed to be sold to the secondary market. Many of these commitments historically have expired without being drawn upon and do not necessarily represent our future cash requirements.
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 contractual or notional amounts of these instruments reflect the extent of involvement we have in a particular class of financial instrument.
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.

50


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 69,907 shares or $1,330 of common stock during the first three months of 2020, as compared to 61,405 shares or $1,433 of common stock during the same period in 2019. We also offer the Directors Plan in which participants purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $123 and $131 during the three-month periods ended March 31, 2020 and March 31, 2019, respectively.
We have publicly announced a common stock repurchase plan. Pursuant to this plan, we repurchased 59,420 shares or $1,168 of common stock during the first three months of 2020 and 26,296 shares or $632 during the first three months of 2019. As of March 31, 2020, we were authorized to repurchase up to an additional 188,486 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.
The common equity tier 1 capital ratio has a minimum requirement of 4.50%. The minimum standard for primary, or Tier 1 capital is 6.00% and the minimum standard for total capital is 8.00%. The minimum requirements presented below include the minimum required capital levels based on the Basel III Capital Rules. Capital requirements to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. The following table sets forth these requirements and our ratios as of:
 March 31, 2020 December 31, 2019
 Actual Minimum Required - BASEL III Required to be Considered Well Capitalized Actual Minimum Required - BASEL III Required to be Considered Well Capitalized
Common equity tier 1 capital12.72% 7.00% 6.50% 12.56% 7.000% 6.50%
Tier 1 capital12.72% 8.50% 8.00% 12.56% 8.500% 8.00%
Total capital13.41% 10.50% 10.00% 13.18% 10.500% 10.00%
Tier 1 leverage9.09% 4.00% 5.00% 9.01% 4.00% 5.00%
There are no significant regulatory constraints placed on our capital. At March 31, 2020, the Bank exceeded minimum capital requirements.
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 $310,622 or 17.11% of assets as of March 31, 2020, compared to $291,190 or 16.05% as of December 31, 2019. The increase in the amount and percentage of primary liquidity is a direct result of an increase in market deposits and a deliberate reduction in non-market funding which required collateralization. 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. Based on these same factors, daily liquidity could vary significantly.
Deposit accounts are our primary source of funds. Our secondary sources include the ability to borrow from the FHLB, from 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. In recent periods, we have elected to use excess funds and proceeds from the sale of AFS securities to reduce borrowings and other higher-cost funding sources. 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, 2020, we had available lines of credit of $140,121.

51


Our stress testing of liquidity increased and our liquidity position strengthened at the end of the first quarter of 2020 as the COVID-19 crisis ensued. The following table outlines our total cash and liquidity as of:

March 31
2020
Total cash and cash equivalents$96,751
Available lines of credit 
Fed funds lines with correspondent banks93,000
FHLB borrowings30,319
FRB Discount Window11,802
Other lines of credit5,000
Total available lines of credit140,121
Unencumbered lendable value of FRB collateral, estimated1
170,000
Total cash and liquidity$406,872
(1) 
Includes estimated unencumbered lendable value of FHLB collateral of $120,000
The following table summarizes our sources and uses of cash for the three-month period ended March 31:

2020 2019 $ Variance
Net cash provided by (used in) operating activities$3,394
 $3,076
 $318
Net cash provided by (used in) investing activities39,991
 (11,095) 51,086
Net cash provided by (used in) financing activities(7,206) (44,773) 37,567
Increase (decrease) in cash and cash equivalents36,179
 (52,792) 88,971
Cash and cash equivalents January 160,572
 73,471
 (12,899)
Cash and cash equivalents March 31$96,751
 $20,679
 $76,072
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 10 – Fair Value” of our interim condensed consolidated financial statements.

52


Market Risk
Our primary market risks are interest rate risk and liquidity risk. 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 banks to effectively manage the various risks that can have a material impact on 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 opportunities 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 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 rate 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. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits.
Gap analysis, the secondary method to measure IRR, measures the cash flows and/or the earliest repricing of our interest bearing assets and liabilities. This analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the embedded repricing options contained in assets and liabilities. Residential real estate and consumer loans allow the borrower to repay the balance prior to maturity without penalty, while commercial and agricultural loans may have prepayment penalties. The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current offering rates, the level of home sales, and the overall availability of credit in the market place. Generally, a decrease in interest rates will result in an increase in cash flows from these assets. A significant portion of our securities are callable or have prepayment options. The call and prepayment options are more likely to be exercised in a period of decreasing interest rates. Savings and demand accounts may generally be withdrawn on request without prior notice. The timing of cash flows from these deposits is estimated based on historical experience. Certificates of deposit have penalties that discourage early withdrawals.
Our primary market risk exposure with the onset of the COVID-19 crisis is uncertain. A review of our market risk methods are ongoing and modeling is incorporating additional assumptions to account for this uncertainty related to this crisis. Repricing, cash flows, and prepayment projections for loans and mortgage-backed securities are not expected to behave as they would be expected to in a more stable interest rate environment. SBA PPP loans and FRB PPP Lending Facility borrowings are new instruments and have payment characteristics that are still uncertain. In late March 2020, we implemented loan payment programs for customers to alleviate the financial setback caused by the temporary closure of businesses and lost wages.  Under these programs, borrowers who were in good standing as of March 1, 2020 can elect to defer full or partial payments for a 90-day period. Our expectations regarding loan payments after the 90-day period is uncertain. Customer deposit flows may experience unusual fluctuations due to government support programs, customer and business stress, and general money supply. We continue to closely monitor customer and economic indicators to develop more precise market risk assumptions as the economic impact of this crisis begins to reveal itself.

53


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, 2020, 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, 2020, 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.

54


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.
Other than the addition of risk related to COVID-19, as described below, 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, 2019.
The COVID-19 pandemic may adversely affect our business
Unexpected and unprecedented changes have occurred during the quarter as the result of COVID-19.  COVID-19 is a new strain of coronavirus that spreads easily from person to person.  The aggressive and persistent virus causes a respiratory disease that currently has no approved vaccine or antiviral treatment and can result in serious illness or death.  The World Health Organization has declared the situation a global pandemic.
The pandemic has created significant market volatility, economic uncertainty, and disruption to normal business operations around the world, with slowdowns and shutdowns affecting entire industries.  The Michigan governor issued on March 23, 2020 a stay-at-home order, which limits gatherings and travel, and requires workers who are not necessary to sustain or protect life to stay home.  The Michigan stay-at-home order has since been extended to May 15.  The orders have led to financial stress for many businesses and workers throughout the communities we serve.
The extent to which COVID-19 impacts our business will depend on future developments, which are highly uncertain and cannot be predicted. Future developments include new information which may emerge concerning the severity of COVID-19 and the actions to contain the coronavirus or treat its impact, among others. We expect the significance of the COVID-19 pandemic, including the extent of its effect on our financial and operational results, to be dictated by, among other factors, its duration, the success of efforts to contain it and the impact of actions taken in response. Uncertainty created by the COVID-19 pandemic is pervasive, and the pandemic will likely impact our operations, customers, vendors and various areas of risk. Other areas of risk include, but are not limited to, cybersecurity, credit, interest rate, litigation and risk related to vendor services. With the uncertainty created by COVID-19, we are not able at this time to estimate the impact of the COVID-19 pandemic on our ongoing financial and operational results.
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 23, 2019, to allow for the repurchase of an additional 250,000 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, 2020, 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      247,906
January 1 - 313,973
 $24.16
 3,973
 243,933
February 1 - 293,322
 24.08
 3,322
 240,611
March 1 -3152,125
 19.01
 52,125
 188,486
Balance, March 3159,420
 $19.64
 59,420
 188,486

55


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

56


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:April 29, 2020  /s/ Jae A. Evans
    Jae A. Evans
    President, Chief Executive Officer
    (Principal Executive Officer)
     
Date:April 29, 2020  /s/ Neil M. McDonnell
    Neil M. McDonnell
    Chief Financial Officer
    (Principal Financial Officer)

57