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ISABELLA BANK Corp - Quarter Report: 2014 September (Form 10-Q)

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2014
or
¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File Number: 0-18415
 
Isabella Bank Corporation
(Exact name of registrant as specified in its charter)
 
Michigan
 
38-2830092
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
401 N. Main St, Mt. Pleasant, MI
 
48858
(Address of principal executive offices)
 
(Zip code)
(989) 772-9471
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ý  Yes    ¨  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ý  Yes    ¨  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
¨
 
Accelerated filer
 
ý
 
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
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 shares outstanding of the registrant’s Common Stock (no par value) was 7,762,481 as of November 4, 2014.


Table of Contents

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

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Table of Contents

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

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PART I – FINANCIAL INFORMATION
Item 1. Interim Condensed Consolidated Financial Statements (Unaudited)
INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
 
September 30
2014
 
December 31
2013
ASSETS
 
 
 
Cash and cash equivalents
 
 
 
Cash and demand deposits due from banks
$
22,431

 
$
21,755

Interest bearing balances due from banks
3,100

 
19,803

Total cash and cash equivalents
25,531

 
41,558

Certificates of deposit held in other financial institutions
580

 
580

Trading securities

 
525

AFS securities (amortized cost of $572,087 in 2014 and $517,614 in 2013)
575,080

 
512,062

Mortgage loans AFS
421

 
1,104

Loans
 
 
 
Commercial
416,824

 
392,104

Agricultural
101,795

 
92,589

Residential real estate
271,033

 
289,931

Consumer
32,647

 
33,413

Gross loans
822,299

 
808,037

Less allowance for loan and lease losses
10,400

 
11,500

Net loans
811,899

 
796,537

Premises and equipment
25,843

 
25,719

Corporate owned life insurance policies
24,957

 
24,401

Accrued interest receivable
6,906

 
5,442

Equity securities without readily determinable fair values
19,063

 
18,293

Goodwill and other intangible assets
46,168

 
46,311

Other assets
17,526

 
20,605

TOTAL ASSETS
$
1,553,974

 
$
1,493,137

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits
 
 
 
Noninterest bearing
$
175,634

 
$
158,428

NOW accounts
192,211

 
192,089

Certificates of deposit under $100 and other savings
468,909

 
455,547

Certificates of deposit over $100
245,136

 
237,702

Total deposits
1,081,890

 
1,043,766

Borrowed funds
290,438

 
279,326

Accrued interest payable and other liabilities
9,570

 
9,436

Total liabilities
1,381,898

 
1,332,528

Shareholders’ equity
 
 
 
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,741,530 shares (including 10,579 shares held in the Rabbi Trust) in 2014 and 7,723,023 shares (including 12,761 shares held in the Rabbi Trust) in 2013
138,023

 
137,580

Shares to be issued for deferred compensation obligations
4,129

 
4,148

Retained earnings
30,410

 
25,222

Accumulated other comprehensive income (loss)
(486
)
 
(6,341
)
Total shareholders’ equity
172,076

 
160,609

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,553,974

 
$
1,493,137

See notes to interim condensed consolidated financial statements.

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Table of Contents

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

Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30
 
2014
 
2013
 
2014
 
2013
Interest income
 
 
 
 
 
 
 
Loans, including fees
$
9,863

 
$
10,330

 
$
29,413

 
$
30,940

AFS securities
 
 
 
 
 
 
 
Taxable
2,016

 
1,787

 
6,007

 
5,419

Nontaxable
1,485

 
1,275

 
4,428

 
3,753

Trading securities

 
7

 
6

 
30

Federal funds sold and other
119

 
106

 
384

 
331

Total interest income
13,483

 
13,505

 
40,238

 
40,473

Interest expense
 
 
 
 
 
 
 
Deposits
1,562

 
1,742

 
4,767

 
5,438

Borrowings
936

 
994

 
2,699

 
2,900

Total interest expense
2,498

 
2,736

 
7,466

 
8,338

Net interest income
10,985

 
10,769

 
32,772

 
32,135

Provision for loan losses
(162
)
 
351

 
(604
)
 
866

Net interest income after provision for loan losses
11,147

 
10,418

 
33,376

 
31,269

Noninterest income
 
 
 
 
 
 
 
Service charges and fees
1,366

 
1,700

 
4,120

 
4,426

Net gain on sale of mortgage loans
170

 
215

 
436

 
822

Earnings on corporate owned life insurance policies
182

 
185

 
556

 
544

Net gains (losses) on sale of AFS securities
97

 
72

 
97

 
171

Other
401

 
690

 
1,690

 
2,082

Total noninterest income
2,216

 
2,862

 
6,899

 
8,045

Noninterest expenses
 
 
 
 
 
 
 
Compensation and benefits
5,174

 
5,340

 
16,045

 
16,021

Furniture and equipment
1,348

 
1,303

 
3,835

 
3,684

Occupancy
697

 
676

 
2,115

 
1,982

Other
2,295

 
2,001

 
6,305

 
6,148

Total noninterest expenses
9,514

 
9,320

 
28,300

 
27,835

Income before federal income tax expense
3,849

 
3,960

 
11,975

 
11,479

Federal income tax expense
444

 
674

 
1,696

 
1,893

NET INCOME
$
3,405

 
$
3,286

 
$
10,279

 
$
9,586

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.44

 
$
0.43

 
$
1.33

 
$
1.25

Diluted
$
0.43

 
$
0.42

 
$
1.30

 
$
1.22

Cash dividends per common share
$
0.22

 
$
0.21

 
$
0.66

 
$
0.63





See notes to interim condensed consolidated financial statements.

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Table of Contents

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

Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30
 
2014
 
2013
 
2014
 
2013
Net income
$
3,405

 
$
3,286

 
$
10,279

 
$
9,586

Unrealized gains (losses) on AFS securities
 
 
 
 
 
 
 
Unrealized gains (losses) arising during the period
(1,326
)
 
665

 
8,642

 
(13,293
)
Reclassification adjustment for net realized (gains) losses included in net income
(97
)
 
(72
)
 
(97
)
 
(171
)
Net unrealized gains (losses)
(1,423
)
 
593

 
8,545

 
(13,464
)
Tax effect (1)
469

 
(447
)
 
(2,690
)
 
4,455

Other comprehensive income (loss), net of tax
(954
)
 
146

 
5,855

 
(9,009
)
Comprehensive income (loss)
$
2,451

 
$
3,432

 
$
16,134

 
$
577

(1) 
See “Note 11 – Accumulated Other Comprehensive Income (Loss)” for tax effect reconciliation.






















See notes to interim condensed consolidated financial statements.

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

Shares
Outstanding
 
Amount
 
Shares to be
Issued for
Deferred
Compensation
Obligations
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Totals
Balance, January 1, 2013
7,671,846

 
$
136,580

 
$
3,734

 
$
19,168

 
$
5,007

 
$
164,489

Comprehensive income (loss)

 

 

 
9,586

 
(9,009
)
 
577

Issuance of common stock
111,904

 
2,754

 

 

 

 
2,754

Common stock issued for deferred compensation obligations

 

 

 

 

 

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

 
122

 
(122
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
423

 

 

 
423

Common stock purchased for deferred compensation obligations

 
(285
)
 

 

 

 
(285
)
Common stock repurchased pursuant to publicly announced repurchase plan
(73,969
)
 
(1,815
)
 

 

 

 
(1,815
)
Cash dividends ($0.63 per share)

 

 

 
(4,838
)
 

 
(4,838
)
Balance, September 30, 2013
7,709,781

 
$
137,356

 
$
4,035

 
$
23,916

 
$
(4,002
)
 
$
161,305

Balance, January 1, 2014
7,723,023

 
$
137,580

 
$
4,148

 
$
25,222

 
$
(6,341
)
 
$
160,609

Comprehensive income (loss)

 

 

 
10,279

 
5,855

 
16,134

Issuance of common stock
122,261

 
2,845

 

 

 

 
2,845

Common stock issued for deferred compensation obligations
6,126

 
143

 
(143
)
 

 

 

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

 
258

 
(258
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
382

 

 

 
382

Common stock purchased for deferred compensation obligations

 
(253
)
 

 

 

 
(253
)
Common stock repurchased pursuant to publicly announced repurchase plan
(110,680
)
 
(2,550
)
 

 

 

 
(2,550
)
Cash dividends ($0.66 per share)

 

 

 
(5,091
)
 

 
(5,091
)
Balance, September 30, 2014
7,740,730

 
$
138,023

 
$
4,129

 
$
30,410

 
$
(486
)
 
$
172,076













See notes to interim condensed consolidated financial statements.

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Table of Contents

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

Nine Months Ended 
 September 30
 
2014
 
2013
OPERATING ACTIVITIES
 
 
 
Net income
$
10,279

 
$
9,586

Reconciliation of net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
(604
)
 
866

Impairment of foreclosed assets
83

 
131

Depreciation
1,902

 
1,903

Amortization of OMSRs
206

 
453

Amortization of acquisition intangibles
143

 
171

Net amortization of AFS securities
1,382

 
1,595

Net (gains) losses on sale of AFS securities
(97
)
 
(171
)
Net unrealized (gains) losses on trading securities
5

 
23

Net gain on sale of mortgage loans
(436
)
 
(822
)
Increase in cash value of corporate owned life insurance policies
(556
)
 
(544
)
Share-based payment awards under equity compensation plan
382

 
423

Origination of loans held-for-sale
(21,746
)
 
(45,992
)
Proceeds from loan sales
22,865

 
49,735

Net changes in operating assets and liabilities which provided (used) cash:
 
 
 
Trading securities
520

 
805

Accrued interest receivable
(1,464
)
 
(1,357
)
Other assets
(958
)
 
319

Accrued interest payable and other liabilities
134

 
622

Net cash provided by (used in) operating activities
12,040

 
17,746

INVESTING ACTIVITIES
 
 
 
Net change in certificates of deposit held in other financial institutions

 
2,420

Activity in AFS securities
 
 
 
Sales
13,362

 
16,229

Maturities and calls
47,527

 
70,164

Purchases
(116,647
)
 
(98,328
)
Loan principal (originations) collections, net
(15,952
)
 
(37,385
)
Proceeds from sales of foreclosed assets
1,482

 
1,788

Purchases of premises and equipment
(2,026
)
 
(2,134
)
Purchases of corporate owned life insurance policies

 
(1,092
)
Proceeds from redemption of corporate owned life insurance policies

 
196

Net cash provided by (used in) investing activities
(72,254
)
 
(48,142
)

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Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
 
Nine Months Ended 
 September 30
 
2014
 
2013
FINANCING ACTIVITIES
 
 
 
Net increase (decrease) in deposits
38,124

 
6,264

Increase (decrease) in borrowed funds
11,112

 
25,000

Cash dividends paid on common stock
(5,091
)
 
(4,838
)
Proceeds from issuance of common stock
2,845

 
2,754

Common stock repurchased
(2,550
)
 
(1,815
)
Common stock purchased for deferred compensation obligations
(253
)
 
(285
)
Net cash provided by (used in) financing activities
44,187

 
27,080

Increase (decrease) in cash and cash equivalents
(16,027
)
 
(3,316
)
Cash and cash equivalents at beginning of period
41,558

 
24,920

Cash and cash equivalents at end of period
$
25,531

 
$
21,604

SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Interest paid
$
7,536

 
$
8,376

Federal income taxes paid
979

 
1,333

SUPPLEMENTAL NONCASH INFORMATION:
 
 
 
Transfers of loans to foreclosed assets
$
1,194

 
$
1,087





















See notes to interim condensed consolidated financial statements.

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NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share amounts)
Note 1 – Basis of Presentation
As used in these notes as well as in Management's Discussion and Analysis of Financial Condition and Results of Operations, references to “Isabella,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiaries. Isabella Bank Corporation refers solely to the parent holding company, and Isabella Bank refers to Isabella Bank Corporation’s subsidiary, Isabella Bank.
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. For further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013.
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, 2013.
Note 2 – Computation of Earnings Per Common Share
Basic earnings per common share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued relate solely to outstanding shares in the Directors Plan.
Earnings per common share have been computed based on the following:
 
Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30

2014
 
2013
 
2014
 
2013
Average number of common shares outstanding for basic calculation
7,733,362

 
7,698,066

 
7,725,706

 
7,689,350

Average potential effect of common shares in the Directors Plan (1)
170,897

 
170,420

 
170,955

 
168,020

Average number of common shares outstanding used to calculate diluted earnings per common share
7,904,259

 
7,868,486

 
7,896,661

 
7,857,370

Net income
$
3,405

 
$
3,286

 
$
10,279

 
$
9,586

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.44

 
$
0.43

 
$
1.33

 
$
1.25

Diluted
$
0.43

 
$
0.42

 
$
1.30

 
$
1.22

(1) 
Exclusive of shares held in the Rabbi Trust
Note 3 – Pending Accounting Standards Updates
ASU No. 2014-01: “Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force)”
In January 2014, ASU No. 2014-01 amended ASC Topic 323, “Investments" to allow investors in low income housing tax credits to use the proportional amortization method if the following criteria are met:
It is probable that the tax credits allocable to the investor will be available.
The investor does not have the ability to exercise significant influence over the operating and financial policies of the limited liability entity.
Substantially all of the projected benefits are from tax credits and other tax benefits (e.g., operating losses).
The investor’s projected yield is based solely on the cash flows from the tax credits and other tax benefits are positive.
The investor is a limited liability investor in the limited liability entity for both legal and tax purposes, and the investor’s liability is limited to its capital investment.

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Investors that do not meet the above criteria must utilize the cost method or equity method in accordance with previously issued authoritative accounting guidance. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2014 and is not expected to have a significant impact on our operations.
ASU No. 2014-04: “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force)”
In January 2014, ASU No. 2014-04 amended ASC Topic 310, “Receivables” to reduce diversity by clarifying when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2014 and is not expected to have a significant impact on our operations.
ASU No. 2014-11: “Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures”
In June 2014, ASU No. 2014-11 amended ASC Topic 860, “Transfers and Servicing” to address concerns that current accounting guidance distinguishes between repurchase agreements that settle at the same time as the maturity of the transferred financial asset and those that settle any time before maturity. The update changes the accounting for repurchase-to-maturity transactions to secured borrowing accounting and, for repurchase financing arrangements, separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2014 and is not expected to impact our financial statement disclosures.
ASU No. 2014-14: “Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force)”
In August 2014, ASU No. 2014-14 amended ASC Topic 310, “Receivables” to provide specific guidance on how to classify and measure foreclosed loans that are government guaranteed. The update requires that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met:
The loan has a government guarantee that is not separable from the loan before foreclosure.
At the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim.
At the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed.
Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2014 and is not expected to have a significant impact on our operations.
ASU No. 2014-15: “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”
In August 2014, ASU No. 2014-15 amended ASC Topic 205, “Presentation of Financial Statements” to provide guidance on how to determine whether to disclose relevant conditions or events that raise substantial doubt about the entity's ability to continue as a going concern. If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, financial statements would continue to be prepared under the going concern assumption; however, disclosures may be necessary depending upon the conditions or events raising substantial doubt. Additionally, if identified substantial doubt is not alleviated after consideration of management’s plans, an entity should include a statement in the footnotes indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or available to be issued). The new authoritative guidance is effective for annual periods beginning after December 15, 2016 and is not expected to impact our financial statement disclosures.

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Note 4 – AFS Securities
The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:
 
September 30, 2014

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
24,645

 
$
5

 
$
733

 
$
23,917

States and political subdivisions
217,195

 
7,337

 
987

 
223,545

Auction rate money market preferred
3,200

 

 
337

 
2,863

Preferred stocks
6,800

 
13

 
640

 
6,173

Mortgage-backed securities
171,856

 
1,144

 
2,233

 
170,767

Collateralized mortgage obligations
148,391

 
1,361

 
1,937

 
147,815

Total
$
572,087

 
$
9,860

 
$
6,867


$
575,080

 
December 31, 2013

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
24,860

 
$
7

 
$
1,122

 
$
23,745

States and political subdivisions
200,323

 
5,212

 
3,547

 
201,988

Auction rate money market preferred
3,200

 

 
623

 
2,577

Preferred stocks
6,800

 
20

 
993

 
5,827

Mortgage-backed securities
147,292

 
657

 
3,834

 
144,115

Collateralized mortgage obligations
135,139

 
1,016

 
2,345

 
133,810

Total
$
517,614

 
$
6,912

 
$
12,464

 
$
512,062

The amortized cost and fair value of AFS securities by contractual maturity at September 30, 2014 are as follows:
 
Maturing
 
Securities with Variable Monthly Payments or Noncontractual Maturities
 
 

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

 
$
9,068

 
$
15,577

 
$

 
$

 
$
24,645

States and political subdivisions
16,838

 
52,050

 
98,035

 
50,272

 

 
217,195

Auction rate money market preferred

 

 

 

 
3,200

 
3,200

Preferred stocks

 

 

 

 
6,800

 
6,800

Mortgage-backed securities

 

 

 

 
171,856

 
171,856

Collateralized mortgage obligations

 

 

 

 
148,391

 
148,391

Total amortized cost
$
16,838

 
$
61,118

 
$
113,612

 
$
50,272

 
$
330,247

 
$
572,087

Fair value
$
16,883


$
63,150


$
116,389


$
51,040


$
327,618

 
$
575,080

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

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A summary of the sales activity of AFS securities was as follows for the three and nine month periods ended:
 
Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30
 
2014
 
2013
 
2014
 
2013
Proceeds from sales of AFS securities
$
13,362


$
6,372


$
13,362


$
16,229

Gross realized gains (losses)
$
97


$
72


$
97


$
171

Applicable income tax expense (benefit)
$
33


$
24


$
33


$
58

The cost basis used to determine the realized gains or losses of AFS securities sold was the amortized cost of the individual investment security as of the trade date.
Information pertaining to AFS securities with gross unrealized losses at September 30, 2014 and December 31, 2013, respectively, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
 
September 30, 2014
 
Less Than Twelve Months
 
Twelve Months or More
 
 

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

 
$

 
$
733

 
$
23,262

 
$
733

States and political subdivisions
106

 
10,836

 
881

 
21,430

 
987

Auction rate money market preferred

 

 
337

 
2,863

 
337

Preferred stocks

 

 
640

 
3,160

 
640

Mortgage-backed securities
165

 
33,358

 
2,068

 
62,800

 
2,233

Collateralized mortgage obligations
323

 
44,308

 
1,614

 
40,702

 
1,937

Total
$
594

 
$
88,502

 
$
6,273

 
$
154,217

 
$
6,867

Number of securities in an unrealized loss position:
 
 
77

 
 
 
96

 
173

 
December 31, 2013
 
Less Than Twelve Months
 
Twelve Months or More
 
 

Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total
Unrealized
Losses
Government sponsored enterprises
$
1,122

 
$
22,873

 
$

 
$

 
$
1,122

States and political subdivisions
2,566

 
42,593

 
981

 
6,115

 
3,547

Auction rate money market preferred

 

 
623

 
2,577

 
623

Preferred stocks

 

 
993

 
2,807

 
993

Mortgage-backed securities
2,424

 
101,816

 
1,410

 
21,662

 
3,834

Collateralized mortgage obligations
2,345

 
84,478

 

 

 
2,345

Total
$
8,457

 
$
251,760

 
$
4,007

 
$
33,161

 
$
12,464

Number of securities in an unrealized loss position:
 
 
182

 
 
 
19

 
201

As of September 30, 2014 and December 31, 2013, we conducted an analysis to determine whether any securities currently in an unrealized loss position should be other-than-temporarily impaired. Such analyses considered, among other factors, the following criteria:
Has the value of the investment declined more than what is deemed to be reasonable based on a risk and maturity adjusted discount rate?
Is the investment credit rating below investment grade?
Is it probable the issuer will be unable to pay the amount when due?
Is it more likely than not that we will have to sell the security before recovery of its cost basis?
Has the duration of the investment been extended?
Based on our analyses, the fact that we have asserted that we do not have the intent to sell AFS securities in an unrealized loss position, and considering it is unlikely that we will have to sell AFS securities in an unrealized loss position before recovery of

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their cost basis, we do not believe that the values of any AFS securities are other-than-temporarily impaired as of September 30, 2014, or December 31, 2013.
Note 5 – Loans and ALLL
We grant commercial, agricultural, residential real estate, and consumer loans to customers situated primarily in Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties in Michigan. The ability of the borrowers to honor their repayment obligations is often dependent upon the real estate, agricultural, light manufacturing, retail, gaming, tourism, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees; a portion of loans are unsecured.
Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and any deferred fees or costs. Interest income is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the level yield method.
The accrual of interest on commercial, agricultural, and residential real estate loans is typically discontinued at the time the loan is 90 days or more past due unless the credit is well-secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
For loans that are placed on nonaccrual status or charged-off, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the ALLL. Loans are typically returned to accrual status after six months of continuous performance. For impaired loans not classified as nonaccrual, interest income continues to be accrued over the term of the loan based on the principal amount outstanding.
Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, farmland and agricultural production, and states and political subdivisions. Repayment of these loans is often dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of credit exposure to any one borrower to $15,000. Borrowers with credit needs of more than $15,000 are serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans generally require loan-to-value limits of less than 80%. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, and property and equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we require annual financial statements, prepare cash flow analyses, and review credit reports as deemed necessary.
We offer adjustable rate mortgages, construction loans, and fixed rate residential real estate loans which typically have amortization periods up to a maximum of 30 years. Fixed rate residential real estate loans with an amortization of greater than 15 years are generally sold upon origination to Freddie Mac. Fixed rate residential real estate loans with an amortization of 15 years or less may be held in our portfolio or sold to Freddie Mac upon origination. We consider the direction of interest rates, the sensitivity of our balance sheet to changes in interest rates, and overall loan demand to determine whether or not to sell these loans to Freddie Mac.
Our lending policies generally limit the maximum loan-to-value ratio on residential real estate loans to 95% of the lower of the appraised value of the property or the purchase price, with the condition that private mortgage insurance is required on loans with loan-to-value ratios in excess of 80%. Substantially all loans upon origination have a loan to value ratio of less than 80%. Underwriting criteria for residential real estate loans include: evaluation of the borrower’s ability to make monthly payments, 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, all debt servicing does not exceed 36% of income, acceptable credit reports, verification of employment, income, and financial information. Appraisals are performed by independent appraisers and reviewed internally. All mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market automated underwriting system; loans in excess of $500 require the approval of our Internal Loan Committee, the Executive Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors.
Consumer loans include secured and unsecured personal loans. Loans are amortized for a period of up to 12 years based on the age and value of the underlying collateral. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market.

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Table of Contents

The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL.
The ALLL is evaluated on a regular basis and is based upon a periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. Specific allocations for impaired loans are primarily determined based on the difference between the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell. Historical loss allocations were calculated at the loan class and segment levels based on a migration analysis of the loan portfolio over the preceding five years. An unallocated component is maintained to cover uncertainties that we believe affect our estimate of probable losses based on qualitative factors. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A summary of changes in the ALLL and the recorded investment in loans by segments follows:
 
Allowance for Loan Losses
 
Three Months Ended September 30, 2014

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
July 1, 2014
$
5,012

 
$
219

 
$
3,981

 
$
802

 
$
686

 
$
10,700

Loans charged-off
(163
)
 

 
(180
)
 
(73
)
 

 
(416
)
Recoveries
171

 

 
68

 
39

 

 
278

Provision for loan losses
(704
)
 
(31
)
 
92

 
(47
)
 
528

 
(162
)
September 30, 2014
$
4,316

 
$
188

 
$
3,961

 
$
721

 
$
1,214

 
$
10,400

 
Allowance for Loan Losses
 
Nine Months Ended September 30, 2014

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
January 1, 2014
$
6,048

 
$
434

 
$
3,845

 
$
639

 
$
534

 
$
11,500

Loans charged-off
(434
)
 
(31
)
 
(557
)
 
(255
)
 

 
(1,277
)
Recoveries
477

 

 
190

 
114

 

 
781

Provision for loan losses
(1,775
)
 
(215
)
 
483

 
223

 
680

 
(604
)
September 30, 2014
$
4,316

 
$
188

 
$
3,961

 
$
721

 
$
1,214

 
$
10,400

 
Allowance for Loan Losses and Recorded Investment in Loans
 
September 30, 2014

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
1,318

 
$

 
$
2,335

 
$
1

 
$

 
$
3,654

Collectively evaluated for impairment
2,998

 
188

 
1,626

 
720

 
1,214

 
6,746

Total
$
4,316

 
$
188

 
$
3,961

 
$
721

 
$
1,214

 
$
10,400

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
11,955

 
$
1,625

 
$
12,925

 
$
69

 
 
 
$
26,574

Collectively evaluated for impairment
404,869

 
100,170

 
258,108

 
32,578

 
 
 
795,725

Total
$
416,824

 
$
101,795

 
$
271,033

 
$
32,647

 
 
 
$
822,299


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Table of Contents

 
Allowance for Loan Losses
 
Three Months Ended September 30, 2013

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
July 1, 2013
$
6,472

 
$
335

 
$
3,676

 
$
647

 
$
570

 
$
11,700

Loans charged-off
(394
)
 
(12
)
 
(94
)
 
(102
)
 

 
(602
)
Recoveries
66

 

 
38

 
47

 

 
151

Provision for loan losses
69

 
108

 
127

 
74

 
(27
)
 
351

September 30, 2013
$
6,213

 
$
431

 
$
3,747

 
$
666

 
$
543

 
$
11,600

 
Allowance for Loan Losses
 
Nine Months Ended September 30, 2013

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
January 1, 2013
$
6,862

 
$
407

 
$
3,627

 
$
666

 
$
374

 
$
11,936

Loans charged-off
(839
)
 
(12
)
 
(681
)
 
(311
)
 

 
(1,843
)
Recoveries
289

 

 
152

 
200

 

 
641

Provision for loan losses
(99
)
 
36

 
649

 
111

 
169

 
866

September 30, 2013
$
6,213

 
$
431

 
$
3,747

 
$
666

 
$
543

 
$
11,600

 
Allowance for Loan Losses and Recorded Investment in Loans
 
December 31, 2013

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,035

 
$
30

 
$
2,287

 
$

 
$

 
$
4,352

Collectively evaluated for impairment
4,013

 
404

 
1,558

 
639

 
534

 
7,148

Total
$
6,048

 
$
434

 
$
3,845

 
$
639

 
$
534

 
$
11,500

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
13,816

 
$
1,538

 
$
14,302

 
$
119

 
 
 
$
29,775

Collectively evaluated for impairment
378,288

 
91,051

 
275,629

 
33,294

 
 
 
778,262

Total
$
392,104


$
92,589

 
$
289,931

 
$
33,413

 
 
 
$
808,037

The following table displays the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit risk ratings as of:
 
September 30, 2014
 
Commercial
 
Agricultural

Real Estate
 
Other
 
Total
 
Real Estate
 
Other
 
Total
Rating
 
 
 
 
 
 
 
 
 
 

2 - High quality
$
14,268

 
$
10,078

 
$
24,346

 
$
6,138

 
$
3,899

 
$
10,037

3 - High satisfactory
90,321

 
47,674

 
137,995

 
27,278

 
13,181

 
40,459

4 - Low satisfactory
186,866

 
41,368

 
228,234

 
30,556

 
16,908

 
47,464

5 - Special mention
9,859

 
1,343

 
11,202

 
1,729

 
68

 
1,797

6 - Substandard
12,139

 
137

 
12,276

 
1,658

 
265

 
1,923

7 - Vulnerable
2,579

 
179

 
2,758

 
115

 

 
115

8 - Doubtful

 
13

 
13

 

 

 

Total
$
316,032

 
$
100,792

 
$
416,824

 
$
67,474

 
$
34,321

 
$
101,795


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Table of Contents

 
December 31, 2013
 
Commercial
 
Agricultural

Real Estate
 
Other
 
Total
 
Real Estate
 
Other
 
Total
Rating
 
 
 
 
 
 
 
 
 
 
 
2 - High quality
$
18,671

 
$
14,461

 
$
33,132

 
$
3,527

 
$
3,235

 
$
6,762

3 - High satisfactory
91,323

 
39,403

 
130,726

 
26,015

 
17,000

 
43,015

4 - Low satisfactory
149,921

 
43,809

 
193,730

 
26,874

 
10,902

 
37,776

5 - Special mention
13,747

 
1,843

 
15,590

 
1,609

 
922

 
2,531

6 - Substandard
16,974

 
473

 
17,447

 
1,232

 
1,273

 
2,505

7 - Vulnerable
1,041

 
238

 
1,279

 

 

 

8 - Doubtful
183

 
17

 
200

 

 

 

Total
$
291,860

 
$
100,244

 
$
392,104

 
$
59,257

 
$
33,332

 
$
92,589

Internally assigned credit risk ratings are reviewed, at a minimum, when loans are renewed or when management has knowledge of improvements or deterioration of the credit quality of individual credits. Descriptions of the internally assigned credit risk ratings for commercial and agricultural loans are as follows:
1. EXCELLENT – Substantially Risk Free
Credit has strong financial condition and solid earnings history, characterized by:
High liquidity, strong cash flow, low leverage.
Unquestioned ability to meet all obligations when due.
Experienced management, with management succession in place.
Secured by cash.
2. HIGH QUALITY – Limited Risk
Credit with sound financial condition and has 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.

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Table of Contents

4. LOW SATISFACTORY – Acceptable Risk
Credit with bankable risks, although some signs of weaknesses are shown:
Would include most start-up businesses.
Occasional instances of trade slowness or repayment delinquency – may have been 10-30 days slow within the past year.
Management’s abilities are apparent, yet unproven.
Weakness in primary source of repayment with adequate secondary source of repayment.
Loan structure generally in accordance with policy.
If secured, loan collateral coverage is marginal.
Adequate cash flow to service debt, but coverage is low.
To be classified as less than satisfactory, only one of the following criteria must be met.
5. SPECIAL MENTION – Criticized
Credit constitutes an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific loan:
Downward trend in sales, profit levels, and margins.
Impaired working capital position.
Cash flow is strained in order to meet debt repayment.
Loan delinquency (30-60 days) and overdrafts may occur.
Shrinking equity cushion.
Diminishing primary source of repayment and questionable secondary source.
Management abilities are questionable.
Weak industry conditions.
Litigation pending against the borrower.
Collateral or guaranty offers limited protection.
Negative debt service coverage, however the credit is well collateralized and payments are current.
6. SUBSTANDARD – Classified
Credit where the borrower’s current net worth, paying capacity, and value of the collateral pledged is inadequate. There is a distinct possibility that we will implement collection procedures if the loan deficiencies are not corrected. In addition, the following characteristics may apply:
Sustained losses have severely eroded the equity and cash flow.
Deteriorating liquidity.
Serious management problems or internal fraud.
Original repayment terms liberalized.
Likelihood of bankruptcy.
Inability to access other funding sources.
Reliance on secondary source of repayment.
Litigation filed against borrower.
Collateral provides little or no value.
Requires excessive attention of the loan officer.
Borrower is uncooperative with loan officer.
7. VULNERABLE – Classified
Credit is considered “Substandard” and warrants placing on nonaccrual. 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.

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Table of Contents

8. DOUBTFUL – Workout
Credit has all the weaknesses inherent in a “Substandard” loan with the added characteristic that collection and/or liquidation is pending. The possibility of a loss is extremely high, but its classification as a loss is deferred until liquidation procedures are completed, or reasonably estimable. Other characteristics that may apply:
Normal operations are severely diminished or have ceased.
Seriously impaired cash flow.
Original repayment terms materially altered.
Secondary source of repayment is inadequate.
Survivability as a “going concern” is impossible.
Collection process has begun.
Bankruptcy petition has been filed.
Judgments have been filed.
Portion of the loan balance has been charged-off.
Our primary credit quality indicator for residential real estate and consumer loans is the individual loan’s past due aging. The following tables summarize the past due and current loans as of:
 
September 30, 2014
 
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
$
315

 
$
58

 
$

 
$
2,579

 
$
2,952

 
$
313,080

 
$
316,032

Commercial other
582

 

 

 
179

 
761

 
100,031

 
100,792

Total commercial
897

 
58

 

 
2,758

 
3,713

 
413,111

 
416,824

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate

 

 

 
115

 
115

 
67,359

 
67,474

Agricultural other
76

 

 

 

 
76

 
34,245

 
34,321

Total agricultural
76

 

 

 
115

 
191

 
101,604

 
101,795

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
1,373

 
254

 
138

 
1,220

 
2,985

 
215,295

 
218,280

Junior liens
265

 

 

 
135

 
400

 
11,397

 
11,797

Home equity lines of credit
330

 
38

 

 
258

 
626

 
40,330

 
40,956

Total residential real estate
1,968

 
292

 
138

 
1,613

 
4,011

 
267,022

 
271,033

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
86

 

 

 
10

 
96

 
28,303

 
28,399

Unsecured
12

 

 
26

 

 
38

 
4,210

 
4,248

Total consumer
98

 

 
26

 
10

 
134

 
32,513

 
32,647

Total
$
3,039

 
$
350

 
$
164

 
$
4,496

 
$
8,049

 
$
814,250

 
$
822,299


19

Table of Contents

 
December 31, 2013
 
Accruing Interest
and Past Due:
 
 
 
Total Past Due and Nonaccrual
 
 
 
 

30-59
Days
 
60-89
Days
 
90 Days
or More
 
Nonaccrual
 
 
Current
 
Total
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
1,226

 
$
296

 
$

 
$
1,136

 
$
2,658

 
$
289,202

 
$
291,860

Commercial other
368

 
15

 
13

 
238

 
634

 
99,610

 
100,244

Total commercial
1,594

 
311

 
13

 
1,374

 
3,292

 
388,812

 
392,104

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate
34

 
295

 

 

 
329

 
58,928

 
59,257

Agricultural other

 

 

 

 

 
33,332

 
33,332

Total agricultural
34

 
295

 

 

 
329

 
92,260

 
92,589

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
3,441

 
986

 
129

 
1,765

 
6,321

 
229,865

 
236,186

Junior liens
408

 
44

 

 
29

 
481

 
13,074

 
13,555

Home equity lines of credit
181

 

 

 
25

 
206

 
39,984

 
40,190

Total residential real estate
4,030

 
1,030

 
129

 
1,819

 
7,008

 
282,923

 
289,931

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
167

 
11

 

 
50

 
228

 
28,444

 
28,672

Unsecured
25

 
5

 

 
1

 
31

 
4,710

 
4,741

Total consumer
192

 
16

 

 
51

 
259

 
33,154

 
33,413

Total
$
5,850

 
$
1,652

 
$
142

 
$
3,244

 
$
10,888

 
$
797,149

 
$
808,037

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

20

Table of Contents

We do not recognize interest income on impaired loans in nonaccrual status. For impaired loans not in nonaccrual status, interest income is recognized daily, as earned, according to the terms of the loan agreement. The following is a summary of information pertaining to impaired loans as of:
 
September 30, 2014
 
December 31, 2013

Outstanding Balance
 
Unpaid Principal Balance
 
Valuation Allowance
 
Outstanding Balance
 
Unpaid Principal Balance
 
Valuation Allowance
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
7,614

 
$
7,732

 
$
1,314

 
$
6,748

 
$
6,888

 
$
1,915

Commercial other
548

 
767

 
4

 
521

 
521

 
120

Agricultural real estate

 

 

 
90

 
90

 
30

Residential real estate senior liens
12,425

 
13,679

 
2,259

 
14,061

 
15,315

 
2,278

Residential real estate junior liens
241

 
251

 
50

 
48

 
64

 
9

Home equity lines of credit
259

 
659

 
26

 

 

 

Consumer secured
59

 
59

 
1

 

 

 

Total impaired loans with a valuation allowance
21,146

 
23,147

 
3,654

 
21,468

 
22,878

 
4,352

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
3,480

 
3,958

 
 
 
5,622

 
6,499

 
 
Commercial other
313

 
324

 
 
 
925

 
1,035

 
 
Agricultural real estate
1,558

 
1,558

 
 
 
1,370

 
1,370

 
 
Agricultural other
67

 
187

 
 
 
78

 
198

 
 
Home equity lines of credit

 

 
 
 
193

 
493

 
 
Consumer secured
10

 
10

 
 
 
119

 
148

 
 
Total impaired loans without a valuation allowance
5,428

 
6,037

 
 
 
8,307

 
9,743

 
 
Impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial
11,955

 
12,781

 
1,318

 
13,816

 
14,943

 
2,035

Agricultural
1,625

 
1,745

 

 
1,538

 
1,658

 
30

Residential real estate
12,925

 
14,589

 
2,335

 
14,302

 
15,872

 
2,287

Consumer
69

 
69

 
1

 
119

 
148

 

Total impaired loans
$
26,574

 
$
29,184

 
$
3,654

 
$
29,775

 
$
32,621

 
$
4,352


21

Table of Contents

The following is a summary of information pertaining to impaired loans for the three and nine month periods ended:
 
Three Months Ended 
 September 30, 2014
 
Nine Months Ended 
 September 30, 2014

Average Outstanding Balance
 
Interest Income Recognized
 
Average Outstanding Balance
 
Interest Income Recognized
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
$
7,063

 
$
106

 
$
6,822

 
$
291

Commercial other
589

 
11

 
746

 
40

Agricultural real estate
102

 

 
113

 

Agricultural other

 

 

 

Residential real estate senior liens
12,440

 
124

 
12,938

 
388

Residential real estate junior liens
167

 
(8
)
 
94

 
(7
)
Home equity lines of credit
310

 
2

 
220

 
13

Consumer secured
62

 
1

 
72

 
3

Total impaired loans with a valuation allowance
20,733

 
236

 
21,005

 
728

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
4,594

 
69

 
5,396

 
262

Commercial other
314

 
5

 
397

 
12

Agricultural real estate
1,460

 
22

 
1,425

 
59

Agricultural other
43

 
1

 
112

 
29

Home equity lines of credit

 

 
32

 

Consumer secured
10

 

 
5

 

Total impaired loans without a valuation allowance
6,421

 
97

 
7,367

 
362

Impaired loans
 
 
 
 
 
 
 
Commercial
12,560

 
191

 
13,361

 
605

Agricultural
1,605

 
23

 
1,650

 
88

Residential real estate
12,917

 
118

 
13,284

 
394

Consumer
72

 
1

 
77

 
3

Total impaired loans
$
27,154

 
$
333

 
$
28,372

 
$
1,090


22

Table of Contents

 
Three Months Ended 
 September 30, 2013
 
Nine Months Ended 
 September 30, 2013

Average Outstanding Balance
 
Interest Income Recognized
 
Average Outstanding Balance
 
Interest Income Recognized
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
$
6,471

 
$
157

 
$
7,546

 
$
378

Commercial other
1,063

 
29

 
976

 
67

Agricultural real estate
91

 
2

 
91

 
4

Agricultural other

 

 
70

 

Residential real estate senior liens
10,865

 
230

 
10,595

 
439

Residential real estate junior liens
80

 
4

 
84

 
5

Home equity lines of credit

 

 

 

Consumer secured

 

 

 

Total impaired loans with a valuation allowance
18,570

 
422

 
19,362

 
893

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
4,531

 
169

 
4,037

 
327

Commercial other
833

 
29

 
1,029

 
88

Agricultural real estate
231

 
15

 
144

 
19

Agricultural other
361

 
2

 
402

 
(2
)
Home equity lines of credit
173

 
8

 
178

 
17

Consumer secured
60

 
1

 
66

 
3

Total impaired loans without a valuation allowance
6,189

 
224

 
5,856

 
452

Impaired loans
 
 
 
 
 
 
 
Commercial
12,898

 
384

 
13,588

 
860

Agricultural
683

 
19

 
707

 
21

Residential real estate
11,118

 
242

 
10,857

 
461

Consumer
60

 
1

 
66

 
3

Total impaired loans
$
24,759

 
$
646

 
$
25,218

 
$
1,345

As of September 30, 2014 and December 31, 2013, we had committed to advance $65 and $134, respectively, in connection with impaired loans, which include TDRs.
Troubled Debt Restructurings
Loan modifications are considered to be TDRs when the modification includes terms outside of normal lending practices to a borrower who is experiencing financial difficulties.
Typical concessions granted include, but are not limited to:
1.
Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics.
2.
Extending the amortization period beyond typical lending guidelines for loans with similar risk characteristics.
3.
Forgiving principal.
4.
Forgiving accrued interest.
To determine if a borrower is experiencing financial difficulties, factors we consider include:
1.
The borrower is currently in default on any of their debt.
2.
The borrower would likely default on any of their debt if the concession was not granted.
3.
The borrower’s cash flow was insufficient to service all of their debt if the concession was not granted.
4.
The borrower has declared, or is in the process of declaring, bankruptcy.
5.
The borrower is unlikely to continue as a going concern (if the entity is a business).

23

Table of Contents

The following is a summary of information pertaining to TDRs granted for the:
 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014

Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
Commercial other
2

 
$
23

 
$
23

 
7

 
$
386

 
$
386

Agricultural other
1

 
49

 
49

 
1

 
49

 
49

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Senior liens
2

 
144

 
144

 
14

 
805

 
805

Junior liens
1

 
40

 
40

 
2

 
81

 
81

Home equity lines of credit

 

 

 
1

 
160

 
160

Total residential real estate
3

 
184

 
184

 
17

 
1,046

 
1,046

Consumer unsecured
1

 
10

 
10

 
4

 
18

 
18

Total
7

 
$
266

 
$
266

 
29

 
$
1,499

 
$
1,499

 
Three Months Ended September 30, 2013
 
Nine Months Ended September 30, 2013

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

 
$
159

 
$
159

 
10

 
$
3,313

 
$
3,116

Agricultural other
1

 
198

 
198

 
2

 
332

 
332

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Senior liens
15

 
1,176

 
1,176

 
30

 
2,611

 
2,595

Junior liens
1

 
20

 
20

 
1

 
20

 
20

Home equity lines of credit

 

 

 

 

 

Total residential real estate
16

 
1,196

 
1,196

 
31

 
2,631

 
2,615

Consumer unsecured
2

 
34

 
34

 
2

 
34

 
34

Total
22

 
$
1,587

 
$
1,587

 
45

 
$
6,310

 
$
6,097

The following tables summarize concessions we granted to borrowers in financial difficulty for the:
 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014

Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
Commercial other
2

 
$
23

 

 
$

 
6

 
$
378

 
1

 
$
8

Agricultural other

 

 
1

 
49

 

 

 
1

 
49

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens

 

 
2

 
144

 
3

 
98

 
11

 
707

Junior liens

 

 
1

 
40

 

 

 
2

 
81

Home equity lines of credit

 

 

 

 
1

 
160

 

 

Total residential real estate

 

 
3

 
184

 
4

 
258

 
13

 
788

Consumer unsecured
1

 
10

 

 

 
3

 
15

 
1

 
3

Total
3

 
$
33

 
4

 
$
233

 
13

 
$
651

 
16

 
$
848


24

Table of Contents

 
Three Months Ended September 30, 2013
 
Nine Months Ended September 30, 2013

Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
Commercial other
3

 
$
159

 

 
$

 
6

 
$
1,517

 
4

 
$
1,796

Agricultural other
1

 
198

 

 

 
2

 
332

 

 

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
10

 
924

 
5

 
252

 
17

 
1,548

 
13

 
1,063

Junior liens

 

 
1

 
20

 

 

 
1

 
20

Home equity lines of credit

 

 

 

 

 

 

 

Total residential real estate
10

 
924

 
6

 
272

 
17

 
1,548

 
14

 
1,083

Consumer unsecured
1

 
16

 
1

 
18

 
1

 
16

 
1

 
18

Total
15

 
$
1,297

 
7

 
$
290

 
26

 
$
3,413

 
19

 
$
2,897

We did not restructure any loans by forgiving principal or accrued interest in the three and nine month periods ended September 30, 2014 or 2013.
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.
Following is a summary of loans that defaulted in the three and nine month periods ended September 30, 2014, which were modified within 12 months prior to the default date:
 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014

Number of Loans
 
Pre-
Default
Recorded
Investment
 
Charge-Off
Recorded
Upon
Default
 
Post-
Default
Recorded
Investment
 
Number of Loans
 
Pre-
Default
Recorded
Investment
 
Charge-Off
Recorded
Upon
Default
 
Post-
Default
Recorded
Investment
Consumer unsecured
2

 
$
7

 
$
7

 
$

 
2

 
$
7

 
$
7

 
$

We had no loans that defaulted in the three and nine month periods ended September 30, 2013, which were modified within 12 months prior to the default date.
The following is a summary of TDR loan balances as of:
 
September 30, 2014
 
December 31, 2013
TDRs
$
24,015

 
$
25,865

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

September 30
2014
 
December 31
2013
FHLB Stock
$
9,100

 
$
8,100

Corporate Settlement Solutions, LLC
6,743

 
6,970

FRB Stock
1,879

 
1,879

Valley Financial Corporation
1,000

 
1,000

Other
341

 
344

Total
$
19,063

 
$
18,293


25

Table of Contents

Note 7 – Borrowed Funds
Borrowed funds consist of the following obligations as of:
 
September 30, 2014
 
December 31, 2013

Amount
 
Rate
 
Amount
 
Rate
FHLB advances
$
182,000

 
1.94
%
 
$
162,000

 
2.02
%
Securities sold under agreements to repurchase without stated maturity dates
89,535

 
0.13
%
 
106,025

 
0.13
%
Securities sold under agreements to repurchase with stated maturity dates
1,203

 
4.24
%
 
11,301

 
3.30
%
Federal funds purchased
17,700

 
0.56
%
 

 

Total
$
290,438

 
1.31
%
 
$
279,326

 
1.35
%
FHLB advances are collateralized by a blanket lien on all qualified 1-4 family residential real estate loans, AFS securities, and FHLB stock.
The following table lists the maturity and weighted average interest rates of FHLB advances as of:
 
September 30, 2014
 
December 31, 2013

Amount
 
Rate
 
Amount
 
Rate
Fixed rate advances due 2014
$
10,000

 
0.48
%
 
$
10,000

 
0.48
%
Fixed rate advances due 2015
42,000

 
0.72
%
 
32,000

 
0.84
%
Fixed rate advances due 2016
10,000

 
2.15
%
 
10,000

 
2.15
%
Fixed rate advances due 2017
30,000

 
1.95
%
 
30,000

 
1.95
%
Fixed rate advances due 2018
40,000

 
2.35
%
 
40,000

 
2.35
%
Fixed rate advances due 2019
20,000

 
3.11
%
 
20,000

 
3.11
%
Fixed rate advances due 2020
10,000

 
1.98
%
 
10,000

 
1.98
%
Fixed rate advances due 2021
10,000

 
2.37
%
 

 

Fixed rate advances due 2023
10,000

 
3.90
%
 
10,000

 
3.90
%
Total
$
182,000

 
1.94
%
 
$
162,000

 
2.02
%
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 $139,350 and $148,930 at September 30, 2014 and December 31, 2013, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.
The following table lists the maturity and weighted average interest rates of securities sold under agreements to repurchase with stated maturity dates as of:
 
September 30
2014
 
December 31
2013
 
Amount
 
Rate
 
Amount
 
Rate
Repurchase agreements due 2014
$
750

 
4.89
%
 
$
10,876

 
3.30
%
Repurchase agreements due 2015
436

 
3.25
%
 
425

 
3.25
%
Repurchase agreements due 2018
17

 
1.00
%
 

 

Total
$
1,203

 
4.24
%
 
$
11,301

 
3.30
%

26

Table of Contents

Securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances generally mature within one to four days from the transaction date. The following table provides a summary of securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances borrowings for the three and nine month periods ended:
 
Three Months Ended September 30, 2014
 
Three Months Ended September 30, 2013
 
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
$
91,472

 
$
88,906

 
0.13
%
 
$
81,405

 
$
78,148

 
0.15
%
Federal funds purchased
17,700

 
2,252

 
0.48
%
 
6,300

 
5,052

 
0.62
%
 
Nine Months Ended September 30, 2014
 
Nine Months Ended September 30, 2013
 
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
$
94,741

 
$
91,231

 
0.13
%
 
$
81,405

 
$
69,224

 
0.15
%
Federal funds purchased
17,700

 
4,939

 
0.48
%
 
13,700

 
4,133

 
0.57
%
We had pledged trading securities, AFS securities, and 1-4 family residential real estate loans in the following amounts at:

September 30
2014
 
December 31
2013
Pledged to secure borrowed funds
$
278,512

 
$
320,173

Pledged to secure repurchase agreements
139,350

 
148,930

Pledged for public deposits and for other purposes necessary or required by law
18,791

 
20,922

Total
$
436,653

 
$
490,025

As of September 30, 2014, we had the ability to borrow up to an additional $111,890, based on assets pledged as collateral. We had no investment securities that are restricted to be pledged for specific purposes.
Note 8 – Other Noninterest Expenses
A summary of expenses included in other noninterest expenses is as follows for the:
 
Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30

2014
 
2013
 
2014
 
2013
Marketing and community relations
$
512

 
$
271

 
$
966

 
$
945

FDIC insurance premiums
196

 
267

 
619

 
812

Directors fees
191

 
203

 
569

 
607

Audit and related fees
185

 
189

 
505

 
490

Education and travel
154

 
110

 
418

 
348

Postage and freight
105

 
103

 
303

 
296

Printing and supplies
89

 
106

 
278

 
291

Loan underwriting fees
83

 
97

 
270

 
336

Consulting fees
96

 
68

 
263

 
223

All other
684

 
587

 
2,114

 
1,800

Total other
$
2,295

 
$
2,001

 
$
6,305

 
$
6,148


27

Table of Contents

Note 9 – Federal Income Taxes
The reconciliation of the provision for federal income taxes and the amount computed at the federal statutory tax rate of 34% of income before federal income tax expense is as follows for the:
 
Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30

2014
 
2013
 
2014
 
2013
Income taxes at 34% statutory rate
$
1,309

 
$
1,347

 
$
4,072

 
$
3,903

Effect of nontaxable income
 
 
 
 
 
 
 
Interest income on tax exempt municipal securities
(501
)
 
(433
)
 
(1,498
)
 
(1,278
)
Earnings on corporate owned life insurance policies
(62
)
 
(63
)
 
(189
)
 
(185
)
Effect of tax credits
(187
)
 
(191
)
 
(575
)
 
(588
)
Other
(158
)
 
(27
)
 
(235
)
 
(79
)
Total effect of nontaxable income
(908
)
 
(714
)
 
(2,497
)
 
(2,130
)
Effect of nondeductible expenses
43

 
41

 
121

 
120

Federal income tax expense
$
444

 
$
674

 
$
1,696

 
$
1,893

Note 10 – Fair Value
Following is a description of the valuation methodologies, key inputs, and an indication of the level of the fair value hierarchy in which the assets or liabilities are classified.
Cash and cash equivalents: The carrying amounts of cash and demand deposits due from banks and interest bearing balances due from banks approximate fair values. As such, we classify cash and cash equivalents as Level 1.
Certificates of deposit held in other financial institutions: Certificates of deposit held in other financial institutions include certificates of deposit and other short term interest bearing balances that mature within 3 years. Fair value is determined using prices for similar assets with similar characteristics. As such, we classify certificates of deposits held in other financial institutions as Level 2.
AFS and trading securities: AFS and trading securities are recorded at fair value on a recurring basis. Level 1 fair value measurement is based upon quoted prices for identical instruments. Level 2 fair value measurement is based upon quoted prices for similar instruments. If quoted prices are not available, fair values are measured using independent pricing models or other model based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions. The values for Level 1 and Level 2 investment securities are generally obtained from an independent third party. On a quarterly basis, we compare the values provided to alternative pricing sources.
Mortgage loans AFS: Mortgage loans AFS are carried at the lower of cost or fair value. The fair value of Mortgage loans AFS are based on what price secondary markets are currently offering for portfolios with similar characteristics. As such, we classify Mortgage loans AFS subject to nonrecurring fair value adjustments as Level 2.
Loans: For variable rate loans with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. As such, we classify loans as Level 3 assets.
We do not record loans at fair value on a recurring basis. However, from time-to-time, loans are classified as impaired and a specific allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will be significantly different than the contractual terms of the original loan agreement are considered impaired. Once a loan is identified as impaired, we measure the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost 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.

28

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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 carry and sell an asset if it is determined that the collateral will be liquidated in connection with the ultimate settlement of the loan. We use these valuations to determine if any specific reserves or charge-offs are necessary. We may obtain new valuations in certain circumstances, including when there has been significant deterioration in the condition of the collateral, if the foreclosure process has begun, or if the existing valuation is deemed to be outdated.
The following tables list the quantitative fair value information about impaired loans as of:

September 30, 2014
Valuation Techniques
Fair Value
Unobservable Input
 
Range
 
 
Discount applied to collateral appraisal:
 
 
 
 
Real Estate
 
20% - 25%
 
 
Equipment
 
30% - 40%
Discounted appraisal value
$8,535
Cash crop inventory
 
40%
 
 
Other inventory
 
75%
 
 
Accounts receivable
 
50%
 
 
Liquor license
 
75%

December 31, 2013
Valuation Techniques
Fair Value
Unobservable Input
 
Range
 
 
Discount applied to collateral appraisal:
 
 
 
 
Real Estate
 
20% - 30%
 
 
Equipment
 
50%
Discounted appraisal value
$13,902
Livestock
 
50%
 
 
Cash crop inventory
 
50%
 
 
Other inventory
 
75%
 
 
Accounts receivable
 
75%
Discount factors with ranges are based on the age of the independent appraisal, broker price opinion, or internal evaluations.
Accrued interest receivable: The carrying amounts of accrued interest receivable approximate fair value. As such, we classify accrued interest receivable as Level 1.
Equity securities without readily determinable fair values: Included in equity securities without readily determinable fair values are FHLB stock and FRB stock as well as our ownership interests in Corporate Settlement Solutions, LLC and Valley Financial Corporation. The investment in Corporate Settlement Solutions, LLC, a title insurance company, was made in the first quarter 2008. We are not the managing entity of Corporate Settlement Solutions, LLC, and therefore, we account for our investment under the equity method of accounting. Valley Financial Corporation is the parent company of 1st State Bank in Saginaw, Michigan, which is a community bank that opened in 2005. We made investments in Valley Financial Corporation in 2004 and in 2007.
The lack of an active market, or other independent sources to validate fair value estimates coupled with the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. As the fair values of these investments are not readily determinable, they are not disclosed under a specific fair value hierarchy; however, they are reviewed quarterly for impairment. If we were to record an impairment adjustment related to these securities, it would be classified as a nonrecurring Level 3 fair value adjustment. During 2014 and 2013, there were no impairments recorded on equity securities without readily determinable fair values.
Foreclosed assets: Upon transfer from the loan portfolio, foreclosed assets (which are included in other assets) are adjusted to and subsequently carried at the lower of carrying value or fair value less costs to sell. Net realizable value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. Due to the inherent level of estimation in the valuation process, we record foreclosed assets as nonrecurring Level 3.

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Table of Contents

The table below lists the quantitative fair value information related to foreclosed assets as of:
 
September 30, 2014
Valuation Techniques
Fair Value
 
Unobservable Input
 
Range
 
 
 
Discount applied to collateral appraisal:
 
 
Discounted appraisal value
$
1,041

 
Real Estate
 
20% - 25%
 
December 31, 2013
Valuation Techniques
Fair Value
 
Unobservable Input
 
Range
 
 
 
Discount applied to collateral appraisal:
 
 
Discounted appraisal value
$
1,412

 
Real Estate
 
20% - 30%
Discount factors with ranges are based on the age of the independent appraisal, broker price opinion, or internal evaluations.
Goodwill and other intangible assets: Acquisition intangibles and goodwill are evaluated for potential impairment on at least an annual basis. Acquisition intangibles and goodwill are typically qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired. If it is determined that the carrying balance of acquisition intangibles or goodwill is more likely than not to be impaired, we perform a cash flow valuation to determine the extent of the potential impairment. If the testing resulted in impairment, we would classify goodwill and other acquisition intangibles subjected to nonrecurring fair value adjustments as Level 3. During 2014 and 2013, there were no impairments recorded on goodwill and other acquisition intangibles.
OMSRs: OMSRs (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, OMSRs are adjusted to fair value through a valuation allowance as determined by the model. As such, we classify OMSRs subject to nonrecurring fair value adjustments as Level 2.
Deposits: The fair value of demand, savings, and money market deposits are, by definition, equal their carrying amounts and are classified as Level 1. Fair values for variable rate certificates of deposit approximate their carrying value. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. As such, fixed rate certificates of deposit are classified as Level 2.
Borrowed funds: The carrying amounts of federal funds purchased, borrowings under overnight repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values. The fair values of other borrowed funds are estimated using discounted cash flow analyses based on current incremental borrowing arrangements. As such, borrowed funds are classified as Level 2.
Accrued interest payable: The carrying amounts of accrued interest payable approximate fair value. As such, we classify accrued interest payable as Level 1.
Commitments to extend credit, standby letters of credit, and undisbursed loans: Our commitments to extend credit, standby letters of credit, and undisbursed funds have no carrying amount and are estimated to have no realizable fair value. Historically, a majority of the unused commitments to extend credit have not been drawn upon and, generally, we do not receive fees in connection with these commitments other than standby letter of credit fees, which are not significant.
The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Although we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement.
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.

30

Table of Contents

The carrying amount and estimated fair value of financial instruments not recorded at fair value in their entirety on a recurring basis were as follows as of:
 
September 30, 2014
 
Carrying
Value
 
Estimated
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
25,531

 
$
25,531

 
$
25,531

 
$

 
$

Certificates of deposit held in other financial institutions
580

 
580

 

 
580

 

Mortgage loans AFS
421

 
434

 

 
434

 

Total loans
822,299

 
822,077

 

 

 
822,077

Less allowance for loan and lease losses
10,400

 
10,400

 

 

 
10,400

Net loans
811,899

 
811,677

 

 

 
811,677

Accrued interest receivable
6,906

 
6,906

 
6,906

 

 

Equity securities without readily determinable fair values (1)
19,063

 
19,063

 

 

 

OMSRs
2,577

 
2,655

 

 
2,655

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
637,320

 
637,320

 
637,320

 

 

Deposits with stated maturities
444,570

 
445,129

 

 
445,129

 

Borrowed funds
290,438

 
293,881

 

 
293,881

 

Accrued interest payable
563

 
563

 
563

 

 

 
December 31, 2013
 
Carrying
Value
 
Estimated
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
41,558

 
$
41,558

 
$
41,558

 
$

 
$

Certificates of deposit held in other financial institutions
580

 
582

 

 
582

 

Mortgage loans AFS
1,104

 
1,123

 

 
1,123

 

Total loans
808,037

 
808,246

 

 

 
808,246

Less allowance for loan and lease losses
11,500

 
11,500

 

 

 
11,500

Net loans
796,537

 
796,746

 

 

 
796,746

Accrued interest receivable
5,442

 
5,442

 
5,442

 

 

Equity securities without readily determinable fair values (1)
18,293

 
18,293

 

 

 

OMSRs
2,555

 
2,667

 

 
2,667

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
593,754

 
593,754

 
593,754

 

 

Deposits with stated maturities
450,012

 
452,803

 

 
452,803

 

Borrowed funds
279,326

 
283,060

 

 
283,060

 

Accrued interest payable
633

 
633

 
633

 

 

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

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Table of Contents

Financial Instruments Recorded at Fair Value
The table below presents the recorded amount of assets and liabilities measured at fair value on:
 
September 30, 2014
 
December 31, 2013

Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Recurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
States and political subdivisions
$

 
$

 
$

 
$

 
$
525

 
$

 
$
525

 
$

AFS securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprises
23,917

 

 
23,917

 

 
23,745

 

 
23,745

 

States and political subdivisions
223,545

 

 
223,545

 

 
201,988

 

 
201,988

 

Auction rate money market preferred
2,863

 

 
2,863

 

 
2,577

 

 
2,577

 

Preferred stocks
6,173

 
6,173

 

 

 
5,827

 
5,827

 

 

Mortgage-backed securities
170,767

 

 
170,767

 

 
144,115

 

 
144,115

 

Collateralized mortgage obligations
147,815

 

 
147,815

 

 
133,810

 

 
133,810

 

Total AFS securities
575,080

 
6,173

 
568,907

 

 
512,062

 
5,827

 
506,235

 

Nonrecurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans (net of the ALLL)
8,535

 

 

 
8,535

 
13,902

 

 

 
13,902

Foreclosed assets
1,041

 

 

 
1,041

 
1,412

 

 

 
1,412

Total
$
584,656

 
$
6,173

 
$
568,907

 
$
9,576

 
$
527,901

 
$
5,827

 
$
506,760

 
$
15,314

Percent of assets and liabilities measured at fair value
 
 
1.06
%
 
97.31
%
 
1.63
%
 
 
 
1.10
%
 
96.00
%
 
2.90
%
The following table provides a summary of the changes in fair value of assets and liabilities recorded at fair value through earnings on a recurring basis and changes in assets and liabilities recorded at fair value on a nonrecurring basis, for which gains or losses were recognized in the:
 
Three Months Ended September 30
 
2014
 
2013

Trading
Losses
 
Other Gains
(Losses)
 
Total
 
Trading
Losses
 
Other Gains
(Losses)
 
Total
Recurring items
 
 
 
 
 
 
 
 
 
 
 
Trading securities
$

 
$

 
$

 
$
(5
)
 
$

 
$
(5
)
Nonrecurring items
 
 
 
 
 
 
 
 
 
 
 
Foreclosed assets

 
(20
)
 
(20
)
 


 
(39
)
 
(39
)
Total
$

 
$
(20
)
 
$
(20
)
 
$
(5
)
 
$
(39
)
 
$
(44
)
 
Nine Months Ended September 30
 
2014
 
2013

Trading
Losses
 
Other Gains
(Losses)
 
Total
 
Trading
Losses
 
Other Gains
(Losses)
 
Total
Recurring items
 
 
 
 
 
 
 
 
 
 
 
Trading securities
$
(5
)
 
$

 
$
(5
)
 
$
(23
)
 
$

 
$
(23
)
Nonrecurring items
 
 
 
 
 
 
 
 
 
 

Foreclosed assets

 
(83
)
 
(83
)
 

 
(131
)
 
(131
)
Total
$
(5
)
 
$
(83
)
 
$
(88
)
 
$
(23
)
 
$
(131
)
 
$
(154
)

32

Table of Contents

Note 11 – Accumulated Other Comprehensive Income (Loss)
The following table summarizes the changes in AOCI by component for the:
 
Three Months Ended September 30
 
2014
 
2013

Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Defined
Benefit
Pension Plan
 
Total
 
Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Defined
Benefit
Pension Plan
 
Total
Balance, July 1
$
2,602

 
$
(2,134
)
 
$
468

 
$
(477
)
 
$
(3,671
)
 
$
(4,148
)
OCI before reclassifications
(1,326
)
 

 
(1,326
)
 
665

 

 
665

Amounts reclassified from AOCI
(97
)
 

 
(97
)
 
(72
)
 

 
(72
)
Subtotal
(1,423
)
 

 
(1,423
)
 
593

 

 
593

Tax effect
469

 

 
469

 
(447
)
 

 
(447
)
OCI, net of tax
(954
)
 

 
(954
)
 
146

 

 
146

Balance, September 30
$
1,648

 
$
(2,134
)
 
$
(486
)
 
$
(331
)
 
$
(3,671
)
 
$
(4,002
)
 
Nine Months Ended September 30
 
2014
 
2013

Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Defined
Benefit
Pension Plan
 
Total
 
Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Defined
Benefit
Pension Plan
 
Total
Balance, January 1
$
(4,207
)
 
$
(2,134
)
 
$
(6,341
)
 
$
8,678

 
$
(3,671
)
 
$
5,007

OCI before reclassifications
8,642

 

 
8,642

 
(13,293
)
 

 
(13,293
)
Amounts reclassified from AOCI
(97
)
 

 
(97
)
 
(171
)
 

 
(171
)
Subtotal
8,545

 

 
8,545

 
(13,464
)
 

 
(13,464
)
Tax effect
(2,690
)
 

 
(2,690
)
 
4,455

 

 
4,455

OCI, net of tax
5,855

 

 
5,855

 
(9,009
)
 

 
(9,009
)
Balance, September 30
$
1,648

 
$
(2,134
)
 
$
(486
)
 
$
(331
)
 
$
(3,671
)
 
$
(4,002
)
Included in OCI for the three and nine month periods ended September 30, 2014 and 2013 are changes in unrealized holding gains and losses related to auction rate money market preferred and preferred stocks. For federal income tax purposes, these securities are considered equity investments. As such, no deferred federal income taxes related to unrealized holding gains or losses are expected or recorded.
A summary of the components of unrealized holding gains on AFS securities included in OCI follows for the:
 
Three Months Ended September 30
 
2014
 
2013

Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
 
Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
Unrealized gains (losses) arising during the period
$
253

 
$
(1,579
)
 
$
(1,326
)
 
$
(653
)
 
$
1,318

 
$
665

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

 
(97
)
 
(97
)
 

 
(72
)
 
(72
)
Net unrealized gains (losses)
253

 
(1,676
)
 
(1,423
)
 
(653
)
 
1,246

 
593

Tax effect

 
469

 
469

 

 
(447
)
 
(447
)
Unrealized gains (losses), net of tax
$
253

 
$
(1,207
)
 
$
(954
)
 
$
(653
)
 
$
799

 
$
146


33

Table of Contents

 
Nine Months Ended September 30
 
2014
 
2013

Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
 
Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
Unrealized gains (losses) arising during the period
$
253

 
$
8,389

 
$
8,642

 
$
(358
)
 
$
(12,935
)
 
$
(13,293
)
Reclassification adjustment for net realized (gains) losses included in net income

 
(97
)
 
(97
)
 

 
(171
)
 
(171
)
Net unrealized gains (losses)
253

 
8,292

 
8,545

 
(358
)
 
(13,106
)
 
(13,464
)
Tax effect

 
(2,690
)
 
(2,690
)
 

 
4,455

 
4,455

Unrealized gains (losses), net of tax
$
253

 
$
5,602

 
$
5,855

 
$
(358
)
 
$
(8,651
)
 
$
(9,009
)
The following table details reclassification adjustments and the related affected line items on our interim condensed consolidated statements of income for the noted periods:
Details about AOCI components
Amount
Reclassified from
AOCI
 
Affected Line Item in the
Interim Condensed Consolidated
Statements of Income

Three Months Ended September 30
 
Nine Months Ended September 30
 
 
 
2014
 
2013
 
2014
 
2013
 
 
Unrealized holding gains (losses) on AFS securities
 
 
 
 
 
 
 
 
 
 
$
97

 
$
72

 
$
97

 
$
171

 
Net gains (losses) on sale of AFS securities
 
97

 
72

 
97

 
171

 
Income before federal income tax expense
 
33

 
24

 
33

 
58

 
Federal income tax expense
 
$
64

 
$
48

 
$
64

 
$
113

 
Net income

34

Table of Contents

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

September 30
2014
 
December 31
2013
ASSETS
 
 
 
Cash on deposit at the Bank
$
2,353

 
$
529

AFS securities
3,279

 
3,542

Investments in subsidiaries
121,580

 
110,192

Premises and equipment
1,959

 
2,013

Other assets
54,604

 
54,223

TOTAL ASSETS
$
183,775

 
$
170,499

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Other liabilities
$
11,699

 
$
9,890

Shareholders' equity
172,076

 
160,609

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
183,775

 
$
170,499

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

2014
 
2013
 
2014
 
2013
Income
 
 
 
 
 
 
 
Dividends from subsidiaries
$
1,750

 
$
1,500

 
$
4,750

 
$
4,500

Interest income
36

 
39

 
114

 
123

Management fee and other
717

 
637

 
1,945

 
1,704

Total income
2,503

 
2,176

 
6,809

 
6,327

Expenses
 
 
 
 
 
 
 
Compensation and benefits
866

 
680

 
2,470

 
2,061

Occupancy and equipment
293

 
132

 
514

 
362

Audit and related fees
109

 
98

 
278

 
256

Other
360

 
230

 
926

 
731

Total expenses
1,628

 
1,140

 
4,188

 
3,410

Income before income tax benefit and equity in undistributed earnings of subsidiaries
875

 
1,036

 
2,621

 
2,917

Federal income tax benefit
298

 
161

 
730

 
549

Income before equity in undistributed earnings of subsidiaries
1,173

 
1,197

 
3,351

 
3,466

Undistributed earnings of subsidiaries
2,232

 
2,089

 
6,928

 
6,120

Net income
$
3,405

 
$
3,286

 
$
10,279

 
$
9,586



35

Table of Contents

Interim Condensed Statements of Cash Flows
 
Nine Months Ended 
 September 30

2014
 
2013
Operating activities
 
 
 
Net income
$
10,279

 
$
9,586

Adjustments to reconcile net income to cash provided by operations
 
 
 
Undistributed earnings of subsidiaries
(6,928
)
 
(6,120
)
Undistributed earnings of equity securities without readily determinable fair values
231

 
14

Share-based payment awards
382

 
423

Depreciation
109

 
136

Net amortization of AFS securities
1

 
1

Changes in operating assets and liabilities which provided (used) cash
 
 
 
Other assets
89

 
(65
)
Accrued interest and other liabilities
1,242

 
939

Net cash provided by (used in) operating activities
5,405

 
4,914

Investing activities
 
 
 
Maturities, calls, and sales of AFS securities
250

 
395

Purchases of premises and equipment
(23
)
 
(140
)
Advances to subsidiaries, net of repayments
641

 
(99
)
Net cash provided by (used in) investing activities
868

 
156

Financing activities
 
 
 
Net increase (decrease) in borrowed funds
600

 
(800
)
Cash dividends paid on common stock
(5,091
)
 
(4,838
)
Proceeds from the issuance of common stock
2,845

 
2,754

Common stock repurchased
(2,550
)
 
(1,815
)
Common stock purchased for deferred compensation obligations
(253
)
 
(285
)
Net cash provided by (used in) financing activities
(4,449
)
 
(4,984
)
Increase (decrease) in cash and cash equivalents
1,824

 
86

Cash and cash equivalents at beginning of period
529

 
332

Cash and cash equivalents at end of period
$
2,353

 
$
418

Note 13 – Operating Segments
Our reportable segments are based on legal entities that account for at least 10% of net operating results. The operations of the Bank as of September 30, 2014 and 2013 and each of the three and nine month periods then ended, represent approximately 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented.

36

Table of Contents

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
ISABELLA BANK CORPORATION FINANCIAL REVIEW
(Dollars in thousands except per share amounts)
This section reviews our financial condition and results of our operations for the three and nine month periods ended September 30, 2014 and 2013. This analysis should be read in conjunction with our 2013 Annual Report on Form 10-K and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 4 of this report.
Executive Summary
During the three and nine month periods ended September 30, 2014, we reported record net income of $3,405 and $10,279 and earnings per common share of $0.44 and $1.33, respectively. Our continued strong earnings have primarily been the result of a continued improvement in various credit quality indicators. These improvements continue to drive declines in the level of the ALLL in both amount and as a percentage of gross loans, resulting in a reversal of provision for loan losses of $604 for the nine month period ended September 30, 2014. Net loans charged-off during the first nine months of 2014 were $496 as compared to $1,202 in the first nine months of 2013. Additionally, we continue to see reductions in loans classified as less than satisfactory. While we experienced reductions in net loans charged-off and in the level of loans classified as less than satisfactory, nonaccrual loans have increased since December 31, 2013. This increase was primarily the result of one loan being classified as nonaccrual in the first quarter of 2014. This loan is well collateralized and closely monitored by management.
While competition for high quality commercial loans continues to be intense, we were able to grow our commercial loan portfolio in the first nine months of 2014 by $24,720 without relaxing our underwriting standards. The growth in commercial and agricultural loans was partially offset by declines in both residential real estate and consumer loans, resulting in a net increase in total loans of $14,262 for the year. The lack of demand for residential real estate loans continues to result in noticeable declines in loan fees and the gain on sale of mortgage loans.
We anticipate that competition for commercial loans will continue to be significant, residential mortgage loan activity will remain soft, and growing our deposit base will be challenging throughout the foreseeable future. Despite these challenges, our unwavering commitment to core community banking principles and long term sustainable growth has, and will continue to, enable us to meet the needs of the communities we serve and increase shareholder value.


37

Table of Contents

Results of Operations

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

September 30
2014
 
June 30
2014
 
March 31
2014
 
December 31
2013
 
September 30
2013
INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
Interest income
$
13,483

 
$
13,391

 
$
13,364

 
$
13,603

 
$
13,505

Interest expense
2,498

 
2,468

 
2,500

 
2,683

 
2,736

Net interest income
10,985

 
10,923

 
10,864

 
10,920

 
10,769

Provision for loan losses
(162
)
 
(200
)
 
(242
)
 
245

 
351

Noninterest income
2,216

 
2,434

 
2,249

 
2,130

 
2,862

Noninterest expenses
9,514

 
9,300

 
9,486

 
9,578

 
9,320

Federal income tax expense
444

 
692

 
560

 
303

 
674

Net Income
$
3,405

 
$
3,565

 
$
3,309

 
$
2,924

 
$
3,286

PER SHARE
 
 
 
 
 
 
 
 
 
Basic earnings
$
0.44

 
$
0.46

 
$
0.43

 
$
0.38

 
$
0.43

Diluted earnings
$
0.43

 
$
0.45

 
$
0.42

 
$
0.37

 
$
0.42

Dividends
$
0.22

 
$
0.22

 
$
0.22

 
$
0.21

 
$
0.21

Tangible book value*
$
16.33

 
$
16.08

 
$
15.82

 
$
15.62

 
$
15.43

Market value
 
 
 
 
 
 
 
 
 
High
$
24.00

 
$
23.50

 
$
23.94

 
$
24.84

 
$
25.50

Low
$
21.73

 
$
22.44

 
$
21.73

 
$
21.12

 
$
23.40

Close*
$
23.60

 
$
22.95

 
$
23.00

 
$
23.85

 
$
24.85

Common shares outstanding*
7,740,730

 
7,735,156

 
7,727,547

 
7,723,023

 
7,709,781

PERFORMANCE RATIOS (annualized)
 
 
 
 
 
 
 
 
 
Return on average total assets
0.89
%
 
0.95
%
 
0.88
%
 
0.80
%
 
0.91
%
Return on average shareholders' equity
7.91
%
 
8.43
%
 
8.04
%
 
7.18
%
 
8.27
%
Return on average tangible shareholders' equity
10.88
%
 
11.59
%
 
10.92
%
 
9.78
%
 
11.16
%
Net interest margin yield (FTE)
3.39
%
 
3.43
%
 
3.42
%
 
3.50
%
 
3.48
%
BALANCE SHEET DATA*
 
 
 
 
 
 
 
 
 
Gross loans
$
822,299

 
$
816,307

 
$
808,411

 
$
808,037

 
$
807,849

AFS securities
$
575,080

 
$
550,518

 
$
555,144

 
$
512,062

 
$
501,057

Total assets
$
1,553,974

 
$
1,522,135

 
$
1,513,371

 
$
1,493,137

 
$
1,459,341

Deposits
$
1,081,890

 
$
1,060,928

 
$
1,065,935

 
$
1,043,766

 
$
1,023,931

Borrowed funds
$
290,438

 
$
279,457

 
$
272,536

 
$
279,326

 
$
266,001

Shareholders' equity
$
172,076

 
$
171,099

 
$
165,971

 
$
160,609

 
$
161,305

Gross loans to deposits
76.01
%
 
76.94
%
 
75.84
%
 
77.42
%
 
78.90
%
ASSETS UNDER MANAGEMENT*
 
 
 
 
 
 
 
 
 
Loans sold with servicing retained
$
290,697

 
$
290,590

 
$
292,382

 
$
293,665

 
$
294,999

Assets managed by our Investment and Trust Services Department
$
374,878

 
$
374,092

 
$
358,811

 
$
351,420

 
$
351,505

Total assets under management
$
2,219,549

 
$
2,186,817

 
$
2,164,564

 
$
2,138,222

 
$
2,105,845

ASSET QUALITY*
 
 
 
 
 
 
 
 
 
Nonperforming loans to gross loans
0.57
%
 
0.58
%
 
0.65
%
 
0.42
%
 
0.53
%
Nonperforming assets to total assets
0.37
%
 
0.38
%
 
0.42
%
 
0.32
%
 
0.37
%
ALLL to gross loans
1.26
%
 
1.31
%
 
1.37
%
 
1.42
%
 
1.44
%
CAPITAL RATIOS*
 
 
 
 
 
 
 
 
 
Shareholders' equity to assets
11.07
%
 
11.24
%
 
10.97
%
 
10.76
%
 
11.05
%
Tier 1 capital to average assets
8.47
%
 
8.50
%
 
8.38
%
 
8.46
%
 
8.45
%
Tier 1 risk-based capital
13.86
%
 
13.84
%
 
13.88
%
 
13.67
%
 
13.75
%
Total risk-based capital
15.11
%
 
15.09
%
 
15.13
%
 
14.92
%
 
15.00
%
* At end of period

38

Table of Contents

The following table outlines our results of operations and provides certain performance measures as of, and for the nine month periods ended:
 
September 30
2014
 
September 30
2013
 
September 30
2012
 
September 30
2011
 
September 30
2010
INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
Interest income
$
40,238

 
$
40,473

 
$
42,556

 
$
43,439

 
$
42,677

Interest expense
7,466

 
8,338

 
10,372

 
12,224

 
12,987

Net interest income
32,772

 
32,135

 
32,184

 
31,215

 
29,690

Provision for loan losses
(604
)
 
866

 
1,100

 
2,383

 
3,231

Noninterest income
6,899

 
8,045

 
8,844

 
5,785

 
6,671

Noninterest expenses
28,300

 
27,835

 
27,889

 
25,879

 
25,249

Federal income tax expense
1,696

 
1,893

 
2,344

 
1,239

 
1,154

Net Income
$
10,279

 
$
9,586


$
9,695

 
$
7,499

 
$
6,727

PER SHARE
 
 
 
 
 
 
 
 
 
Basic earnings
$
1.33

 
$
1.25

 
$
1.28

 
$
0.99

 
$
0.89

Diluted earnings
$
1.30

 
$
1.22

 
$
1.24

 
$
0.97

 
$
0.87

Dividends
$
0.66

 
$
0.63

 
$
0.60

 
$
0.57

 
$
0.54

Tangible book value*
$
16.33

 
$
15.43

 
$
14.65

 
$
20.53

 
$
19.59

Market value
 
 
 
 
 
 
 
 
 
High
$
24.00

 
$
26.00

 
$
24.98

 
$
19.25

 
$
19.00

Low
$
21.73

 
$
21.55

 
$
22.30

 
$
17.10

 
$
15.75

Close*
$
23.60

 
$
24.85

 
$
22.50

 
$
18.75

 
$
17.39

Common shares outstanding*
7,740,730

 
7,709,781

 
7,611,350

 
7,578,257

 
7,532,859

PERFORMANCE RATIOS (annualized)
 
 
 
 
 
 
 
 
 
Return on average total assets
0.90
%
 
0.89
%
 
0.94
%
 
0.79
%
 
0.77
%
Return on average shareholders' equity
8.13
%
 
7.84
%
 
8.37
%
 
6.84
%
 
6.35
%
Return on average tangible shareholders' equity
10.95
%
 
11.02
%
 
11.96
%
 
10.17
%
 
9.54
%
Net interest margin yield (FTE)
3.41
%
 
3.50
%
 
3.72
%
 
3.90
%
 
4.04
%
BALANCE SHEET DATA*
 
 
 
 
 
 
 
 
 
Gross loans
$
822,299

 
$
807,849

 
$
766,751

 
$
750,163

 
$
726,069

AFS securities
$
575,080

 
$
501,057

 
$
467,414

 
$
415,879

 
$
302,212

Total assets
$
1,553,974

 
$
1,459,341

 
$
1,389,138

 
$
1,324,093

 
$
1,215,098

Deposits
$
1,081,890

 
$
1,023,931

 
$
989,491

 
$
942,441

 
$
861,066

Borrowed funds
$
290,438

 
$
266,001

 
$
226,580

 
$
216,888

 
$
198,895

Shareholders' equity
$
172,076

 
$
161,305

 
$
164,147

 
$
155,579

 
$
147,596

Gross loans to deposits
76.01
%
 
78.90
%
 
77.49
%
 
79.60
%
 
84.32
%
ASSETS UNDER MANAGEMENT*
 
 
 
 
 
 
 
 
 
Loans sold with servicing retained
$
290,697

 
$
294,999

 
$
304,523

 
$
303,063

 
$
313,102

Assets managed by our Investment and Trust Services Department
$
374,878

 
$
351,505

 
$
321,661

 
$
284,286

 
$
288,798

Total assets under management
$
2,219,549

 
$
2,105,845

 
$
2,015,322

 
$
1,911,442

 
$
1,816,998

ASSET QUALITY*
 
 
 
 
 
 
 
 
 
Nonperforming loans to gross loans
0.57
%
 
0.53
%
 
0.98
%
 
0.81
%
 
1.15
%
Nonperforming assets to total assets
0.37
%
 
0.37
%
 
0.68
%
 
0.61
%
 
0.86
%
ALLL to gross loans
1.26
%
 
1.44
%
 
1.57
%
 
1.65
%
 
1.79
%
CAPITAL RATIOS*
 
 
 
 
 
 
 
 
 
Shareholders' equity to assets
11.07
%
 
11.05
%
 
11.82
%
 
11.75
%
 
12.15
%
Tier 1 capital to average assets
8.47
%
 
8.45
%
 
8.27
%
 
8.10
%
 
8.28
%
Tier 1 risk-based capital
13.86
%
 
13.75
%
 
13.35
%
 
12.43
%
 
12.42
%
Total risk-based capital
15.11
%
 
15.00
%
 
14.60
%
 
13.68
%
 
13.67
%
* At end of period

39

Table of Contents

Average Balances, Interest Rate, and Net Interest Income
The following schedules present the daily average amount outstanding for each major category of interest earning assets, nonearning assets, interest bearing liabilities, and noninterest bearing liabilities. These schedules also present an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a FTE basis using a 34% federal income tax rate. Nonaccrual loans, for the purpose of the following computations, are included in the average loan balances. FRB and FHLB restricted equity holdings are included in accrued income and other assets.
 
Three Months Ended
 
September 30, 2014
 
June 30, 2014
 
September 30, 2013

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
$
817,364

 
$
9,863

 
4.83
%
 
$
808,541

 
$
9,799

 
4.85
%
 
$
806,128

 
$
10,330

 
5.13
%
Taxable investment securities
358,547

 
2,016

 
2.25
%
 
353,878

 
1,993

 
2.25
%
 
330,832

 
1,787

 
2.16
%
Nontaxable investment securities
196,522

 
2,359

 
4.80
%
 
194,307

 
2,376

 
4.89
%
 
166,122

 
2,056

 
4.95
%
Trading account securities

 

 
%
 
172

 
2

 
4.65
%
 
815

 
11

 
5.40
%
Other
28,431

 
119

 
1.67
%
 
21,421

 
112

 
2.09
%
 
23,690

 
106

 
1.79
%
Total earning assets
1,400,864

 
14,357

 
4.10
%
 
1,378,319

 
14,282

 
4.14
%
 
1,327,587

 
14,290

 
4.31
%
NONEARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses
(10,705
)
 
 
 
 
 
(11,208
)
 
 
 
 
 
(11,867
)
 
 
 
 
Cash and demand deposits due from banks
20,360

 
 
 
 
 
17,403

 
 
 
 
 
18,430

 
 
 
 
Premises and equipment
25,872

 
 
 
 
 
25,960

 
 
 
 
 
26,160

 
 
 
 
Accrued income and other assets
98,853

 
 
 
 
 
97,187

 
 
 
 
 
90,993

 
 
 
 
Total assets
$
1,535,244

 
 
 
 
 
$
1,507,661

 
 
 
 
 
$
1,451,303

 
 
 
 
INTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
$
193,659

 
40

 
0.08
%
 
$
192,798

 
39

 
0.08
%
 
$
183,795

 
40

 
0.09
%
Savings deposits
265,814

 
94

 
0.14
%
 
257,628

 
91

 
0.14
%
 
245,318

 
94

 
0.15
%
Time deposits
447,046

 
1,428

 
1.28
%
 
455,592

 
1,459

 
1.28
%
 
454,387

 
1,608

 
1.42
%
Borrowed funds
274,358

 
936

 
1.36
%
 
263,606

 
879

 
1.33
%
 
260,308

 
994

 
1.53
%
Total interest bearing liabilities
1,180,877

 
2,498

 
0.85
%
 
1,169,624

 
2,468

 
0.84
%
 
1,143,808

 
2,736

 
0.96
%
NONINTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
171,085

 
 
 
 
 
158,804

 
 
 
 
 
139,519

 
 
 
 
Other
11,114

 
 
 
 
 
10,166

 
 
 
 
 
9,117

 
 
 
 
Shareholders’ equity
172,168

 
 
 
 
 
169,067

 
 
 
 
 
158,859

 
 
 
 
Total liabilities and shareholders’ equity
$
1,535,244

 
 
 
 
 
$
1,507,661

 
 
 
 
 
$
1,451,303

 
 
 
 
Net interest income (FTE)
 
 
$
11,859

 
 
 
 
 
$
11,814

 
 
 
 
 
$
11,554

 
 
Net yield on interest earning assets (FTE)
 
 
 
 
3.39
%
 
 
 
 
 
3.43
%
 
 
 
 
 
3.48
%

40

Table of Contents

 
Nine Months Ended
 
September 30, 2014
 
September 30, 2013

Average
Balance
 
Tax
Equivalent
Interest
 
Average
Yield /
Rate
 
Average
Balance
 
Tax
Equivalent
Interest
 
Average
Yield /
Rate
INTEREST EARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
Loans
$
810,572

 
$
29,413

 
4.84
%
 
$
784,593

 
$
30,940

 
5.26
%
Taxable investment securities
355,146

 
6,007

 
2.26
%
 
338,527

 
5,419

 
2.13
%
Nontaxable investment securities
193,276

 
7,056

 
4.87
%
 
161,472

 
6,080

 
5.02
%
Trading account securities
232

 
9

 
5.17
%
 
1,180

 
45

 
5.08
%
Other
25,485

 
384

 
2.01
%
 
25,866

 
331

 
1.71
%
Total earning assets
1,384,711

 
42,869

 
4.13
%
 
1,311,638

 
42,815

 
4.35
%
NONEARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
ALLL
(11,182
)
 
 
 
 
 
(11,947
)
 
 
 
 
Cash and demand deposits due from banks
18,484

 
 
 
 
 
18,083

 
 
 
 
Premises and equipment
25,950

 
 
 
 
 
26,005

 
 
 
 
Accrued income and other assets
96,915

 
 
 
 
 
97,513

 
 
 
 
Total assets
$
1,514,878

 
 
 
 
 
$
1,441,292

 
 
 
 
INTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
$
194,744

 
120

 
0.08
%
 
$
183,879

 
121

 
0.09
%
Savings deposits
258,807

 
279

 
0.14
%
 
242,989

 
275

 
0.15
%
Time deposits
451,329

 
4,368

 
1.29
%
 
458,767

 
5,042

 
1.47
%
Borrowed funds
269,325

 
2,699

 
1.34
%
 
245,344

 
2,900

 
1.58
%
Total interest bearing liabilities
1,174,205

 
7,466

 
0.85
%
 
1,130,979

 
8,338

 
0.98
%
NONINTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
161,688

 
 
 
 
 
138,654

 
 
 
 
Other
10,380

 
 
 
 
 
8,631

 
 
 
 
Shareholders’ equity
168,605

 
 
 
 
 
163,028

 
 
 
 
Total liabilities and shareholders’ equity
$
1,514,878

 
 
 
 
 
$
1,441,292

 
 
 
 
Net interest income (FTE)
 
 
$
35,403

 
 
 
 
 
$
34,477

 
 
Net yield on interest earning assets (FTE)
 
 
 
 
3.41
%
 
 
 
 
 
3.50
%
Net Interest Income
Net interest income is the amount by which interest income on earning assets exceeds the interest expenses on interest bearing liabilities. Net interest income is influenced by changes in the balance and mix of assets and liabilities and market interest rates. We exert some control over these factors; however, FRB monetary policy and competition have a significant impact. For analytical purposes, net interest income is adjusted to an FTE basis by adding the income tax savings from interest on tax exempt loans, AFS securities, and trading securities, thus making year to year comparisons more meaningful. Included in interest income are loan fees for the three and nine month periods ended:
 
Three Months Ended
 
Nine Months Ended
 
September 30
2014
 
June 30
2014
 
September 30
2013
 
September 30
2014
 
September 30
2013
Loan fees
$
488

 
$
566

 
$
738

 
$
1,530

 
$
2,421



41

Table of Contents

Volume and Rate Variance Analysis
The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. For the purpose of this table, changes in interest due to volume and rate were determined as follows:
Volume—change in volume multiplied by the previous period's rate.
Rate—change in the FTE rate multiplied by the previous period's volume.
The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
 
Three Months Ended 
 September 30, 2014 Compared to 
 June 30, 2014 
 Increase (Decrease) Due to
 
Three Months Ended 
 September 30, 2014 Compared to 
 September 30, 2013 
 Increase (Decrease) Due to
 
Nine Months Ended 
 September 30, 2014 Compared to 
 September 30, 2013 
 Increase (Decrease) Due to

Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Changes in interest income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans
$
107

 
$
(43
)
 
$
64

 
$
142

 
$
(609
)
 
$
(467
)
 
$
1,000

 
$
(2,527
)
 
$
(1,527
)
Taxable AFS securities
26

 
(3
)
 
23

 
154

 
75

 
229

 
273

 
315

 
588

Nontaxable AFS securities
27

 
(44
)
 
(17
)
 
367

 
(64
)
 
303

 
1,166

 
(190
)
 
976

Trading securities
(1
)
 
(1
)
 
(2
)
 
(5
)
 
(6
)
 
(11
)
 
(37
)
 
1

 
(36
)
Other
32

 
(25
)
 
7

 
20

 
(7
)
 
13

 
(5
)
 
58

 
53

Total changes in interest income
191

 
(116
)
 
75

 
678

 
(611
)
 
67

 
2,397

 
(2,343
)
 
54

Changes in interest expense
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits

 
1

 
1

 
2

 
(2
)
 

 
7

 
(8
)
 
(1
)
Savings deposits
3

 

 
3

 
8

 
(8
)
 

 
17

 
(13
)
 
4

Time deposits
(27
)
 
(4
)
 
(31
)
 
(26
)
 
(154
)
 
(180
)
 
(81
)
 
(593
)
 
(674
)
Borrowed funds
36

 
21

 
57

 
52

 
(110
)
 
(58
)
 
267

 
(468
)
 
(201
)
Total changes in interest expense
12

 
18

 
30

 
36

 
(274
)
 
(238
)
 
210

 
(1,082
)
 
(872
)
Net change in interest margin (FTE)
$
179

 
$
(134
)
 
$
45

 
$
642

 
$
(337
)
 
$
305

 
$
2,187

 
$
(1,261
)
 
$
926

Our net yield on interest earning assets remains at historically low levels which is a direct result of FRB monetary policy. While we do anticipate that the FRB will increase short term interest rates in 2015, we do not expect any significant improvements in our net yield on interest earning assets as the rates paid on interest bearing liabilities will likely increase faster than those of interest earning assets. In the interim, net interest income will increase only through continued balance sheet growth.
 
Average Yield / Rate for the Three Month Periods Ended:

September 30
2014

June 30
2014

March 31
2014

December 31
2013

September 30
2013
Total earning assets
4.10
%
 
4.14
%
 
4.14
%
 
4.30
%
 
4.31
%
Total interest bearing liabilities
0.85
%
 
0.84
%
 
0.85
%
 
0.94
%
 
0.96
%
Net yield on interest earning assets (FTE)
3.39
%

3.43
%
 
3.42
%
 
3.50
%
 
3.48
%

42

Table of Contents

 
Quarter to Date Net Interest Income (FTE)

September 30
2014
 
June 30
2014
 
March 31
2014
 
December 31
2013
 
September 30
2013
Total interest income (FTE)
$
14,357

 
$
14,282

 
$
14,242

 
$
14,441

 
$
14,290

Total interest expense
2,498

 
2,468

 
2,500

 
2,683

 
2,736

Net interest income (FTE)
$
11,859

 
$
11,814

 
$
11,742

 
$
11,758

 
$
11,554

One of the the primary contributors to the decline in the net yield on interest earning assets during 2014 was a drastic decline in loan fees. Loan fees have declined as the demand for residential mortgage loans has diminished and the competition for commercial loans remains intense. As shown in the following table, the net yield on interest earning assets and net interest income excluding the impact of loan fees (FTE) has remained essentially unchanged since the third quarter of 2013.

September 30
2014
 
June 30
2014
 
March 31
2014
 
December 31
2013
 
September 30
2013
Net interest income (FTE)
$
11,859

 
$
11,814

 
$
11,742

 
$
11,758

 
$
11,554

Less loan fees
488

 
566

 
476

 
761

 
738

Net interest income excluding loan fees (FTE)
$
11,371

 
$
11,248

 
$
11,266

 
$
10,997

 
$
10,816

Net yield on interest earning assets excluding loan fees (FTE)
3.25
%
 
3.26
%
 
3.28
%
 
3.27
%
 
3.26
%
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 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 reflection of other qualitative risks that reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
The following table summarizes our charge-off and recovery activity for the three and nine month periods ended September 30:
 
Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30

2014
 
2013
 
2014
 
2013
ALLL at beginning of period
$
10,700

 
$
11,700

 
$
11,500

 
$
11,936

Loans charged-off
 
 
 
 
 
 
 
Commercial and agricultural
163

 
406

 
465

 
851

Residential real estate
180

 
94

 
557

 
681

Consumer
73

 
102

 
255

 
311

Total loans charged-off
416

 
602

 
1,277

 
1,843

Recoveries
 
 
 
 
 
 
 
Commercial and agricultural
171

 
66

 
477

 
289

Residential real estate
68

 
38

 
190

 
152

Consumer
39

 
47

 
114

 
200

Total recoveries
278

 
151

 
781

 
641

Net loans charged-off
138

 
451

 
496

 
1,202

Provision for loan losses
(162
)
 
351

 
(604
)
 
866

ALLL at end of period
$
10,400

 
$
11,600

 
$
10,400

 
$
11,600

Net loans charged-off to average loans outstanding
0.02
%
 
0.06
%
 
0.06
%
 
0.15
%


43

Table of Contents

The following table summarizes our charge-offs, recoveries, provisions for loan losses, and ALLL balances as of, and for the three month periods ended:

September 30
2014
 
June 30
2014
 
March 31
2014
 
December 31
2013
 
September 30
2013
Total loans charged-off
$
416

 
$
411

 
$
450

 
$
497

 
$
602

Total recoveries
278

 
211

 
292

 
152

 
151

Net loans charged-off
138

 
200

 
158

 
345

 
451

Net loans charged-off to average loans outstanding
0.02
 %
 
0.02
 %
 
0.02
 %
 
0.04
%
 
0.06
%
Provision for loan losses
$
(162
)
 
$
(200
)
 
$
(242
)
 
$
245

 
$
351

Provision for loan losses to average loans outstanding
(0.02
)%
 
(0.02
)%
 
(0.03
)%
 
0.03
%
 
0.04
%
ALLL
$
10,400

 
$
10,700

 
$
11,100

 
$
11,500

 
$
11,600

ALLL as a% of loans at end of period
1.26
 %
 
1.31
 %
 
1.37
 %
 
1.42
%
 
1.44
%
As the level of net loans charged-off continues to decline and credit quality indicators continue to improve, we have reduced the ALLL in both amount and as a percentage of loans. For further discussion of the allocation of the ALLL, see “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
Loans Past Due and Loans in Nonaccrual Status
Increases in past due and nonaccrual 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 loans. We monitor all loans that are past due and in nonaccrual status for indicators of additional deterioration.
 
Total Past Due and Nonaccrual

September 30
2014
 
June 30
2014
 
March 31
2014
 
December 31
2013
 
September 30
2013
Commercial and agricultural
$
3,904

 
$
5,045

 
$
4,986

 
$
3,621

 
$
5,371

Residential real estate
4,011

 
4,613

 
7,067

 
7,008

 
6,339

Consumer
134

 
98

 
113

 
259

 
152

Total
$
8,049

 
$
9,756

 
$
12,166

 
$
10,888

 
$
11,862

Total past due and nonaccrual loans to gross loans
0.98
%
 
1.20
%
 
1.50
%
 
1.35
%
 
1.47
%
Loans past due and nonaccrual have continued to decline during the third quarter of 2014. Overall, declines in past due and nonaccrual loans during 2014 are the result of strengthened loan performance, as the majority of the loans were current as of September 30, 2014.
A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual loans by type, is included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
Troubled Debt Restructurings
We have taken a proactive approach to avoid foreclosures on borrowers who are willing to work with us in modifying their loans, thus making them more affordable. While this approach has allowed certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure, it has contributed to a significant increase in the level of loans classified as TDRs. The modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. At the time of the TDR, the loan is reviewed to determine whether or not to classify the loan as accrual or nonaccrual. The majority of new 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.
We restructure debt with borrowers who due to temporary financial difficulties are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, forgive principal, forgive interest, or a combination of these modifications. Typically, the modifications are for a period of five years or less. There were no TDRs that were Government sponsored as of September 30, 2014 or December 31, 2013.

44

Table of Contents

Losses associated with TDRs, if any, are included in the estimation of the ALLL in the quarter in which a loan is identified as a TDR, and we review the analysis of the ALLL estimation each reporting period to ensure its continued appropriateness.
The following tables provide a roll-forward of TDRs for the:

Three Months Ended September 30, 2014
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
July 1, 2014
162

 
$
21,265

 
18

 
$
2,927

 
180

 
$
24,192

New modifications
7

 
266

 

 

 
7

 
266

Principal advances (payments)

 
(241
)
 

 
34

 

 
(207
)
Loans paid-off
(5
)
 
(101
)
 
(1
)
 
(2
)
 
(6
)
 
(103
)
Partial charge-off

 

 

 
(75
)
 

 
(75
)
Balances charged-off
(2
)
 
(7
)
 
(1
)
 
(51
)
 
(3
)
 
(58
)
Transfers to OREO

 

 

 

 

 

Transfers to accrual status
1

 
109

 
(1
)
 
(109
)
 

 

Transfers to nonaccrual status
(1
)
 
(55
)
 
1

 
55

 

 

September 30, 2014
162

 
$
21,236

 
16

 
$
2,779

 
178

 
$
24,015


Nine Months Ended September 30, 2014
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
January 1, 2014
165

 
$
24,423

 
15

 
$
1,442

 
180

 
$
25,865

New modifications
25

 
1,254

 
4

 
245

 
29

 
1,499

Principal advances (payments)

 
(1,323
)
 

 
(40
)
 

 
(1,363
)
Loans paid-off
(20
)
 
(1,371
)
 
(3
)
 
(90
)
 
(23
)
 
(1,461
)
Partial charge-off

 
(70
)
 

 
(193
)
 

 
(263
)
Balances charged-off
(3
)
 
(13
)
 
(1
)
 
(51
)
 
(4
)
 
(64
)
Transfers to OREO

 

 
(4
)
 
(198
)
 
(4
)
 
(198
)
Transfers to accrual status
4

 
429

 
(4
)
 
(429
)
 

 

Transfers to nonaccrual status
(9
)
 
(2,093
)
 
9

 
2,093

 

 

September 30, 2014
162

 
$
21,236

 
16

 
$
2,779

 
178

 
$
24,015


Three Months Ended September 30, 2013
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
July 1, 2013
123

 
$
19,134

 
15

 
$
1,723

 
138

 
$
20,857

New modifications
18

 
1,262

 
4

 
326

 
22

 
1,588

Principal advances (payments)

 
(180
)
 

 
(22
)
 

 
(202
)
Loans paid-off
(4
)
 
(1,273
)
 
(1
)
 
(103
)
 
(5
)
 
(1,376
)
Partial charge-off

 

 

 
(197
)
 

 
(197
)
Balances charged-off

 

 

 

 

 

Transfers to OREO

 

 
(4
)
 
(333
)
 
(4
)
 
(333
)
Transfers to accrual status

 

 

 

 

 

Transfers to nonaccrual status
(3
)
 
(317
)
 
3

 
317

 

 

September 30, 2013
134

 
$
18,626

 
17

 
$
1,711

 
151

 
$
20,337


45

Table of Contents


Nine Months Ended September 30, 2013
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
January 1, 2013
115

 
$
16,531

 
19

 
$
2,824

 
134

 
$
19,355

New modifications
40

 
5,673

 
5

 
424

 
45

 
6,097

Principal advances (payments)

 
(643
)
 

 
(265
)
 

 
(908
)
Loans paid-off
(14
)
 
(2,492
)
 
(6
)
 
(800
)
 
(20
)
 
(3,292
)
Partial charge-off

 
(15
)
 

 
(408
)
 

 
(423
)
Balances charged-off
(3
)
 
(147
)
 

 

 
(3
)
 
(147
)
Transfers to OREO

 

 
(5
)
 
(345
)
 
(5
)
 
(345
)
Transfers to accrual status
1

 
105

 
(1
)
 
(105
)
 

 

Transfers to nonaccrual status
(5
)
 
(386
)
 
5

 
386

 

 

September 30, 2013
134

 
$
18,626

 
17

 
$
1,711

 
151

 
$
20,337

The following table summarizes our TDRs as of:
 
September 30, 2014
 
December 31, 2013
 
 

Accruing
Interest
 
Nonaccrual
 
Total
 
Accruing
Interest
 
Nonaccrual
 
Total
 
Total
Change
Current
$
20,410

 
$
868

 
$
21,278

 
$
21,690

 
$
1,189

 
$
22,879

 
$
(1,601
)
Past due 30-59 days
635

 
307

 
942

 
2,158

 
37

 
2,195

 
(1,253
)
Past due 60-89 days
191

 
4

 
195

 
575

 

 
575

 
(380
)
Past due 90 days or more

 
1,600

 
1,600

 

 
216

 
216

 
1,384

Total
$
21,236

 
$
2,779

 
$
24,015

 
$
24,423

 
$
1,442

 
$
25,865

 
$
(1,850
)
Additional disclosures about TDRs are included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

46

Table of Contents

Impaired Loans
The following is a summary of information pertaining to impaired loans as of:
 
September 30, 2014
 
December 31, 2013

Outstanding
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
 
Outstanding
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
TDRs
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
10,254

 
$
10,614

 
$
1,303

 
$
10,663

 
$
11,193

 
$
1,585

Commercial other
778

 
1,008

 
4

 
1,310

 
1,340

 
62

Agricultural real estate
1,443

 
1,443

 

 
1,459

 
1,459

 
30

Agricultural other
67

 
187

 

 
79

 
199

 

Residential real estate senior liens
11,156

 
11,761

 
2,064

 
12,266

 
12,841

 
2,010

Residential real estate junior liens
99

 
99

 
20

 
20

 
20

 
4

Home equity lines of credit
159

 
459

 
16

 

 

 

Consumer secured
59

 
59

 
1

 
68

 
69

 

Total TDRs
24,015

 
25,630

 
3,408

 
25,865

 
27,121

 
3,691

Other impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
841

 
1,077

 
11

 
1,707

 
2,193

 
330

Commercial other
82

 
82

 

 
136

 
217

 
58

Agricultural real estate
115

 
115

 

 

 

 

Agricultural other

 

 

 

 

 

Residential real estate senior liens
1,269

 
1,918

 
195

 
1,795

 
2,473

 
268

Residential real estate junior liens
142

 
152

 
30

 
28

 
45

 
5

Home equity lines of credit
100

 
200

 
10

 
193

 
493

 

Consumer secured
10

 
10

 

 
51

 
79

 

Total other impaired loans
2,559

 
3,554

 
246

 
3,910

 
5,500

 
661

Total impaired loans
$
26,574

 
$
29,184

 
$
3,654

 
$
29,775

 
$
32,621

 
$
4,352

Additional disclosure related to impaired loans is included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
Nonperforming Assets
The following table summarizes our nonperforming assets as of:

September 30
2014
 
June 30
2014
 
March 31
2014
 
December 31
2013
 
September 30
2013
Nonaccrual loans
$
4,496

 
$
4,587

 
$
4,345

 
$
3,244

 
$
3,812

Accruing loans past due 90 days or more
164

 
119

 
893

 
142

 
457

Total nonperforming loans
4,660

 
4,706

 
5,238

 
3,386

 
4,269

Foreclosed assets
1,041

 
1,132

 
1,126

 
1,412

 
1,186

Total nonperforming assets
$
5,701

 
$
5,838

 
$
6,364

 
$
4,798

 
$
5,455

Nonperforming loans as a % of total loans
0.57
%
 
0.58
%
 
0.65
%
 
0.42
%
 
0.53
%
Nonperforming assets as a % of total assets
0.37
%
 
0.38
%
 
0.42
%
 
0.32
%
 
0.37
%
After a loan is 90 days past due, it is generally placed in nonaccrual status unless it is well secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Loans may be placed back on accrual status after six months months of continued performance.

47

Table of Contents

Included in the nonaccrual loan balances above were loans currently classified as TDRs as of:

September 30
2014
 
December 31
2013
Commercial and agricultural
$
2,071

 
$
833

Residential real estate
708

 
609

Total
$
2,779

 
$
1,442

The following table lists individually significant commercial and agricultural loan relationships in nonaccrual status as of September 30, 2014 and December 31, 2013. To be classified as individually significant, the recorded investment in nonaccrual loans to each borrower must have exceeded $1,000 as of the end of either period.
 
September 30, 2014
 
December 31, 2013

Outstanding
Balance
 
Specific
Allocation
 
Outstanding
Balance
 
Specific
Allocation
Borrower 1
$
1,179

 
$

1 
 
$

 
$

Others not individually significant
3,317

 
 
 
 
3,244

 
 
Total
$
4,496

 
 
 
 
$
3,244

 
 
1 No specific allocation was established as the loan was collateral dependent and the net realizable value of the underlying collateral value exceeded the loan's carrying balance.
Additional disclosures about nonaccrual loans are included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recording of a charge-off. We believe that all loans deemed to be impaired have been identified.
We believe that the level of the ALLL is appropriate as of September 30, 2014 and we will continue to closely monitor overall credit quality and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains appropriate.

48

Table of Contents

Noninterest Income and Noninterest Expenses
Noninterest income consists of service charges and fees, gains on sale of mortgage loans, earnings on corporate owned life insurance policies, gains and losses on sales of AFS securities, and other income. Significant account balances are highlighted in the following table with additional descriptions of significant fluctuations:

Three Months Ended September 30
 
 
 
 
 
Change
 
2014
 
2013
 
$
 
%
Service charges and fees
 
 
 
 
 
 
 
NSF and overdraft fees
$
565

 
$
601

 
$
(36
)
 
(5.99
)%
ATM and debit card fees
538

 
509

 
29

 
5.70
 %
Freddie Mac servicing fee
178

 
183

 
(5
)
 
(2.73
)%
Service charges on deposit accounts
92

 
96

 
(4
)
 
(4.17
)%
Net OMSRs income (loss)
(41
)
 
278

 
(319
)
 
(114.75
)%
All other
34

 
33

 
1

 
3.03
 %
Total service charges and fees
1,366

 
1,700

 
(334
)
 
(19.65
)%
Gain on sale of mortgage loans
170

 
215

 
(45
)
 
(20.93
)%
Earnings on corporate owned life insurance policies
182

 
185

 
(3
)
 
(1.62
)%
Gains (losses) on sale of AFS securities
97

 
72

 
25

 
34.72
 %
Other
 
 
 
 
 
 
 
Trust and brokerage advisory fees
506

 
466

 
40

 
8.58
 %
Other
(105
)
 
224

 
(329
)
 
(146.88
)%
Total other
401

 
690

 
(289
)
 
(41.88
)%
Total noninterest income
$
2,216

 
$
2,862

 
$
(646
)
 
(22.57
)%

Nine Months Ended September 30
 
 
 
 
 
Change
 
2014
 
2013
 
$
 
%
Service charges and fees
 
 
 
 
 
 
 
NSF and overdraft fees
$
1,630

 
$
1,675

 
$
(45
)
 
(2.69
)%
ATM and debit card fees
1,559

 
1,453

 
106

 
7.30
 %
Freddie Mac servicing fee
541

 
554

 
(13
)
 
(2.35
)%
Service charges on deposit accounts
267

 
281

 
(14
)
 
(4.98
)%
Net OMSRs income (loss)
22

 
374

 
(352
)
 
(94.12
)%
All other
101

 
89

 
12

 
13.48
 %
Total service charges and fees
4,120

 
4,426

 
(306
)
 
(6.91
)%
Gain on sale of mortgage loans
436

 
822

 
(386
)
 
(46.96
)%
Earnings on corporate owned life insurance policies
556

 
544

 
12

 
2.21
 %
Gains (losses) on sale of AFS securities
97

 
171

 
(74
)
 
(43.27
)%
Other
 
 
 
 
 
 
 
Trust and brokerage advisory fees
1,532

 
1,359

 
173

 
12.73
 %
Other
158

 
723

 
(565
)
 
(78.15
)%
Total other
1,690

 
2,082

 
(392
)
 
(18.83
)%
Total noninterest income
$
6,899

 
$
8,045

 
$
(1,146
)
 
(14.24
)%

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Table of Contents

Significant changes in noninterest income are detailed below:
As customers continue to increase their dependence on ATM and debit cards, we have realized a corresponding increase in fees. We do not anticipate significant changes to our ATM and debit fee structure; however, we do expect that these fees will continue to increase as the usage of ATM and debit cards increase.
Offering rates on residential mortgage loans, as well as the decline in loan demand, are the most significant drivers behind fluctuations in the gain on sale of mortgage loans and net OMSRs income (loss). As a result of the lack of demand in residential mortgage loan originations, we are experiencing declines in both the gain on sale of mortgage loans and net OMSRs income (loss). As mortgage rates are expected to approximate current levels in the foreseeable future and purchase money mortgage activity will likely remain soft, we do not anticipate any significant changes in origination volumes or the gain on sale of mortgage loans.
We are continually analyzing our AFS securities for potential sale opportunities. These analyses identified several mortgage-backed securities pools in 2014 and 2013 that made economic sense to sell. We do not anticipate any significant investment sales for the remainder of 2014.
In recent periods, we have invested considerable efforts to increase our market share in trust and brokerage advisory services. These efforts have translated into increases in trust fees and brokerage and advisory fees. We expect this trend to continue.
The fluctuations in all other income is spread throughout various categories, none of which are individually significant. We do not anticipate any significant fluctuations from current levels for the remainder of 2014.

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Table of Contents

Noninterest expenses include compensation and benefits, furniture and equipment, occupancy, and other expenses. Significant account balances are highlighted in the following table with additional descriptions of significant fluctuations:

Three Months Ended September 30
 
 
 
 
 
Change
 
2014
 
2013
 
$
 
%
Compensation and benefits
 
 
 
 
 
 
 
Employee salaries
$
4,026

 
$
3,920

 
$
106

 
2.70
 %
Employee benefits
1,148

 
1,420

 
(272
)
 
(19.15
)%
Total compensation and benefits
5,174

 
5,340

 
(166
)
 
(3.11
)%
Furniture and equipment
 
 
 
 
 
 
 
Service contracts
660

 
603

 
57

 
9.45
 %
Depreciation
485

 
488

 
(3
)
 
(0.61
)%
ATM and debit card fees
188

 
191

 
(3
)
 
(1.57
)%
All other
15

 
21

 
(6
)
 
(28.57
)%
Total furniture and equipment
1,348

 
1,303

 
45

 
3.45
 %
Occupancy
 
 
 
 
 
 
 
Outside services
168

 
168

 

 
 %
Depreciation
175

 
166

 
9

 
5.42
 %
Utilities
128

 
127

 
1

 
0.79
 %
Property taxes
131

 
124

 
7

 
5.65
 %
All other
95

 
91

 
4

 
4.40
 %
Total occupancy
697

 
676

 
21

 
3.11
 %
Other
 
 
 
 
 
 
 
Marketing and community relations
512

 
271

 
241

 
88.93
 %
FDIC insurance premiums
196

 
267

 
(71
)
 
(26.59
)%
Directors fees
191

 
203

 
(12
)
 
(5.91
)%
Audit and related fees
185

 
189

 
(4
)
 
(2.12
)%
Education and travel
154

 
110

 
44

 
40.00
 %
Postage and freight
105

 
103

 
2

 
1.94
 %
Printing and supplies
89

 
106

 
(17
)
 
(16.04
)%
Loan underwriting fees
83

 
97

 
(14
)
 
(14.43
)%
Consulting fees
96

 
68

 
28

 
41.18
 %
All other
684

 
587

 
97

 
16.52
 %
Total other
2,295

 
2,001

 
294

 
14.69
 %
Total noninterest expenses
$
9,514

 
$
9,320

 
$
194

 
2.08
 %

51

Table of Contents


Nine Months Ended September 30
 
 
 
 
 
Change
 
2014
 
2013
 
$
 
%
Compensation and benefits
 
 
 
 
 
 
 
Employee salaries
$
12,114

 
$
11,640

 
$
474

 
4.07
 %
Employee benefits
3,931

 
4,381

 
(450
)
 
(10.27
)%
Total compensation and benefits
16,045

 
16,021

 
24

 
0.15
 %
Furniture and equipment
 
 
 
 
 
 
 
Service contracts
1,871

 
1,673

 
198

 
11.84
 %
Depreciation
1,379

 
1,411

 
(32
)
 
(2.27
)%
ATM and debit card fees
542

 
544

 
(2
)
 
(0.37
)%
All other
43

 
56

 
(13
)
 
(23.21
)%
Total furniture and equipment
3,835

 
3,684

 
151

 
4.10
 %
Occupancy
 
 
 
 
 
 
 
Outside services
543

 
489

 
54

 
11.04
 %
Depreciation
523

 
492

 
31

 
6.30
 %
Utilities
403

 
382

 
21

 
5.50
 %
Property taxes
396

 
393

 
3

 
0.76
 %
All other
250

 
226

 
24

 
10.62
 %
Total occupancy
2,115

 
1,982

 
133

 
6.71
 %
Other
 
 
 
 
 
 
 
Marketing and community relations
966

 
945

 
21

 
2.22
 %
FDIC insurance premiums
619

 
812

 
(193
)
 
(23.77
)%
Directors fees
569

 
607

 
(38
)
 
(6.26
)%
Audit and related fees
505

 
490

 
15

 
3.06
 %
Education and travel
418

 
348

 
70

 
20.11
 %
Postage and freight
303

 
296

 
7

 
2.36
 %
Printing and supplies
278

 
291

 
(13
)
 
(4.47
)%
Loan underwriting fees
270

 
336

 
(66
)
 
(19.64
)%
Consulting fees
263

 
223

 
40

 
17.94
 %
All other
2,114

 
1,800

 
314

 
17.44
 %
Total other
6,305

 
6,148

 
157

 
2.55
 %
Total noninterest expenses
$
28,300

 
$
27,835

 
$
465

 
1.67
 %
Significant changes in noninterest expenses are detailed below:
Employee salaries have increased as a result of normal merit increases and additional staffing required by our continued growth. The decline in employee benefits is related to health care costs as a result of lower than anticipated claims. Employee benefits are expected to increase moderately in future periods as a result of anticipated increases in health care costs.
Service contracts have increased during 2014 due to costs related to data lines as well as increases in various other contracts as we continue to expand our on-line services offered to customers. Service contracts are anticipated to approximate current levels for the remainder of 2014.
We have consistently been a strong supporter of the various communities, schools, and charities in the markets we serve. We sponsor a foundation, which we established in 1996, that is funded by discretionary donations. The affiliated foundation provides centralized oversight for donations to organizations that benefit our communities. Included in marketing and community relations were discretionary donations to the foundation of $250 and $200 for the nine month periods ended September 30, 2014 and 2013, respectively.

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Table of Contents

FDIC insurance premiums were elevated in 2013 as a result of us receiving less of a refund for prepaid FDIC insurance premiums than we had anticipated. FDIC insurance premiums have returned to normalized levels and are anticipated to approximate current levels for the remainder of 2014.
Loan underwriting fees have declined in 2014 as a result of declines in residential real estate loan originations.
The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.
Analysis of Changes in Financial Condition

September 30
2014
 
December 31
2013
 
$ Change
 
% Change
(unannualized)
ASSETS
 
 
 
 
 
 
 
Cash and cash equivalents
$
25,531

 
$
41,558

 
$
(16,027
)
 
(38.57
)%
Certificates of deposit held in other financial institutions
580

 
580

 

 

Trading securities

 
525

 
(525
)
 
(100.00
)%
AFS securities
 
 
 
 
 
 
 
Amortized cost of AFS securities
572,087

 
517,614

 
54,473

 
10.52
 %
Unrealized Gains (losses) on AFS securities
2,993

 
(5,552
)
 
8,545

 
N/M

AFS securities
575,080

 
512,062

 
63,018

 
12.31
 %
Mortgage loans AFS
421

 
1,104

 
(683
)
 
(61.87
)%
Loans
 
 
 
 


 
 
Gross loans
822,299

 
808,037

 
14,262

 
1.77
 %
Less allowance for loan and lease losses
10,400

 
11,500

 
(1,100
)
 
(9.57
)%
Net loans
811,899

 
796,537

 
15,362

 
1.93
 %
Premises and equipment
25,843

 
25,719

 
124

 
0.48
 %
Corporate owned life insurance policies
24,957

 
24,401

 
556

 
2.28
 %
Accrued interest receivable
6,906

 
5,442

 
1,464

 
26.90
 %
Equity securities without readily determinable fair values
19,063

 
18,293

 
770

 
4.21
 %
Goodwill and other intangible assets
46,168

 
46,311

 
(143
)
 
(0.31
)%
Other assets
17,526

 
20,605

 
(3,079
)
 
(14.94
)%
TOTAL ASSETS
$
1,553,974

 
$
1,493,137

 
$
60,837

 
4.07
 %
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Deposits
$
1,081,890

 
$
1,043,766

 
$
38,124

 
3.65
 %
Borrowed funds
290,438

 
279,326

 
11,112

 
3.98
 %
Accrued interest payable and other liabilities
9,570

 
9,436

 
134

 
1.42
 %
Total liabilities
1,381,898

 
1,332,528

 
49,370

 
3.70
 %
Shareholders’ equity
172,076

 
160,609

 
11,467

 
7.14
 %
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,553,974

 
$
1,493,137

 
$
60,837

 
4.07
 %
The following table outlines the changes in loans:

September 30
2014
 
December 31
2013
 
$ Change
 
% Change
(unannualized)
Commercial
$
416,824

 
$
392,104

 
$
24,720

 
6.30
 %
Agricultural
101,795

 
92,589

 
9,206

 
9.94
 %
Residential real estate
271,033

 
289,931

 
(18,898
)
 
(6.52
)%
Consumer
32,647

 
33,413

 
(766
)
 
(2.29
)%
Total
$
822,299

 
$
808,037

 
$
14,262

 
1.77
 %

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Table of Contents

The following table displays loan balances as of:

September 30
2014
 
June 30
2014
 
March 31
2014
 
December 31
2013
 
September 30
2013
Commercial
$
416,824

 
$
407,791

 
$
399,702

 
$
392,104

 
$
388,973

Agricultural
101,795

 
97,661

 
92,059

 
92,589

 
92,927

Residential real estate
271,033

 
278,545

 
284,586

 
289,931

 
291,825

Consumer
32,647

 
32,310

 
32,064

 
33,413

 
34,124

Total
$
822,299

 
$
816,307

 
$
808,411

 
$
808,037

 
$
807,849

We continue to see declines in residential real estate loans which have been offset by increases in commercial and agricultural loans. This trend is likely to continue as the demand for residential real estate loans is anticipated to remain soft due to continuing uncertainty in the residential real estate markets, increases in interest rates, and the implementation of CFPB underwriting guidelines.
The following table outlines the changes in deposits:

September 30
2014
 
December 31
2013
 
$ Change
 
% Change
(unannualized)
Noninterest bearing demand deposits
$
175,634

 
$
158,428

 
$
17,206

 
10.86
 %
Interest bearing demand deposits
192,211

 
192,089

 
122

 
0.06
 %
Savings deposits
269,475

 
243,237

 
26,238

 
10.79
 %
Certificates of deposit
341,153

 
362,473

 
(21,320
)
 
(5.88
)%
Brokered certificates of deposit
74,132

 
56,329

 
17,803

 
31.61
 %
Internet certificates of deposit
29,285

 
31,210

 
(1,925
)
 
(6.17
)%
Total
$
1,081,890

 
$
1,043,766

 
$
38,124

 
3.65
 %
The following table displays deposit balances as of:

September 30
2014
 
June 30
2014
 
March 31
2014
 
December 31
2013
 
September 30
2013
Noninterest bearing demand deposits
$
175,634

 
$
162,537

 
$
158,241

 
$
158,428

 
$
143,013

Interest bearing demand deposits
192,211

 
186,705

 
194,407

 
192,089

 
186,630

Savings deposits
269,475

 
260,038

 
261,444

 
243,237

 
245,217

Certificates of deposit
341,153

 
346,200

 
356,847

 
362,473

 
366,349

Brokered certificates of deposit
74,132

 
75,031

 
65,273

 
56,329

 
51,410

Internet certificates of deposit
29,285

 
30,417

 
29,723

 
31,210

 
31,312

Total
$
1,081,890

 
$
1,060,928

 
$
1,065,935

 
$
1,043,766

 
$
1,023,931

Overall, deposits have grown considerably since September 30, 2013. As a result of the current interest rate environment, we continue to see declines in certificates of deposits, but these declines have been offset by increases in noninterest bearing demand deposits, interest bearing demand deposits, and savings accounts. We expect this trend to continue for the foreseeable future.

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Table of Contents

The current interest rate environment has made it almost impossible to increase net interest income without increasing earning assets. As deposit growth has generally outpaced loan demand, we continue to deploy deposits into purchases of AFS securities to provide additional interest income. In addition to utilizing deposits, we also utilize borrowings and brokered deposits to fund earning assets. We anticipate that future increases in our AFS securities will be in the form of mortgage-backed securities and collateralized mortgage obligations. The following table displays fair values of AFS securities as of:

September 30
2014
 
June 30
2014
 
March 31
2014
 
December 31
2013
 
September 30
2013
Government sponsored enterprises
$
23,917

 
$
24,104

 
$
23,883

 
$
23,745

 
$
24,155

States and political subdivisions
223,545

 
214,210

 
219,644

 
201,988

 
193,786

Auction rate money market preferred
2,863

 
2,867

 
2,755

 
2,577

 
2,639

Preferred stocks
6,173

 
6,214

 
6,053

 
5,827

 
6,144

Mortgage-backed securities
170,767

 
162,992

 
157,856

 
144,115

 
146,393

Collateralized mortgage obligations
147,815

 
140,131

 
144,953

 
133,810

 
127,940

Total
$
575,080

 
$
550,518

 
$
555,144

 
$
512,062

 
$
501,057

The following table displays borrowed funds balances as of:

September 30
2014
 
June 30
2014
 
March 31
2014
 
December 31
2013
 
September 30
2013
FHLB advances
$
182,000

 
$
182,000

 
$
162,000

 
$
162,000

 
$
162,000

Securities sold under agreements to repurchase without stated maturity dates
89,535

 
87,058

 
94,741

 
106,025

 
81,405

Securities sold under agreements to repurchase with stated maturity dates
1,203

 
1,199

 
1,195

 
11,301

 
16,296

Federal funds purchased
17,700

 
9,200

 
14,600

 

 
6,300

Total
$
290,438

 
$
279,457

 
$
272,536

 
$
279,326

 
$
266,001

Capital
Capital consists solely of common stock, retained earnings, and accumulated other comprehensive income (loss). We are currently authorized to raise capital through dividend reinvestment, employee and director stock purchases, and shareholder stock purchases. Pursuant to these authorizations, we issued 122,261 shares or $2,845 of common stock during the first nine months of 2014, as compared to 111,904 shares or $2,754 of common stock during the same period in 2013. We also offer the Directors Plan in which participants either directly purchase stock or purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $382 and $423 during the nine month periods ended September 30, 2014 and 2013, respectively.
We have approved a publicly announced common stock repurchase plan. Pursuant to this plan, we repurchased 110,680 shares or $2,550 of common stock compared to 73,969 shares for $1,815 during the first nine months of 2014 and 2013, respectively. As of September 30, 2014, we were authorized to repurchase up to an additional 26,716 shares of common stock.
There are no significant regulatory constraints placed on our capital. The FRB’s current recommended minimum primary capital to assets requirement is 6.00%. Our primary capital to adjusted average assets, which consists of shareholders' equity plus the ALLL acquisition intangibles, was 8.47% as of September 30, 2014.
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 minimum standard is 8.00%, of which at least 4.00% must consist of equity capital net of goodwill. The following table sets forth the percentages required under the Risk Based Capital guidelines and our values as of:

September 30
2014
 
December 31
2013
 
Required
Equity Capital
13.86
%
 
13.67
%
 
4.00
%
Secondary Capital
1.25
%
 
1.25
%
 
4.00
%
Total Capital
15.11
%
 
14.92
%
 
8.00
%

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Table of Contents

Secondary capital includes only the ALLL. The percentage for the secondary capital under the required column is the maximum amount allowed from all sources.
The FRB and FDIC also prescribe minimum capital requirements for Isabella Bank. At September 30, 2014, the Bank exceeded these minimum capital requirements. On July 2, 2013, the FRB published revised BASEL III Capital standards for banks. The rules redefine what is included or deducted from equity capital, changes risk weighting for certain on and off-balance sheet assets, increases the minimum required equity capital to be considered well capitalized, and introduces a capital cushion buffer. The rules, which will be gradually phased in between 2015 and 2019, are not expected to have a material impact on our operations.
Contractual Obligations and Loan Commitments
We are party to credit related financial instruments with off-balance-sheet risk. These financial instruments are entered into in the normal course of business to meet the financing needs of our customers. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of these instruments reflect the extent of involvement we have in a particular class of financial instrument.
The following table summarizes our credit related financial instruments with off-balance-sheet risk as of:

September 30
2014
 
December 31
2013
Unfunded commitments under lines of credit
$
108,071

 
$
121,959

Commercial and standby letters of credit
3,375

 
4,169

Commitments to grant loans
21,125

 
29,096

Total
$
132,571

 
$
155,224

Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. These commitments may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements.
Commercial and standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements, including commercial paper, bond financing, and similar transactions. These commitments to extend credit and letters of credit generally mature within one year. The credit risk involved in these transactions is essentially the same as that involved in extending loans to customers. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon the extension of credit, is based on a credit evaluation of the borrower. While we consider standby letters of credit to be guarantees, the amount of the liability related to such guarantees on the commitment date is not significant and a liability related to such guarantees is not recorded on the consolidated balance sheets.
Commitments to grant loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The amount of collateral obtained, if it is deemed necessary, is based on management’s credit evaluation of the customer. Commitments to grant loans include loans committed to be sold to the secondary market.
Our exposure to credit-related loss in the event of nonperformance by the counter parties to the financial instruments for commitments to extend credit and standby letters of credit could be up to the contractual notional amount of those instruments. We use the same credit policies as we do for extending loans to customers. No significant losses are anticipated as a result of these commitments.
Fair Value
We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Trading securities, AFS securities, 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, foreclosed assets, OMSRs, 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 notes to the interim condensed consolidated financial statements.

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Table of Contents

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, certificates of deposit held in other financial institutions, trading securities, and AFS securities. These categories totaled $601,191 or 38.69% of assets as of September 30, 2014 as compared to $554,725 or 37.15% as of December 31, 2013. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Liquidity varies significantly daily, based on customer activity.
Our primary source of funds is deposit accounts. We also have the ability to borrow from the FHLB, the FRB, and through various correspondent banks in the form of federal funds purchased. These funding methods typically carry a higher interest rate than traditional market deposit accounts. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form AFS securities or loans as collateral. As of September 30, 2014, we had available lines of credit of $111,890.
The following table summarizes our sources and uses of cash for the nine month periods ended September 30:
 
2014
 
2013
 
$ Variance
Net cash provided by (used in) operating activities
$
12,040

 
$
17,746

 
$
(5,706
)
Net cash provided by (used in) investing activities
(72,254
)
 
(48,142
)
 
(24,112
)
Net cash provided by (used in) financing activities
44,187

 
27,080

 
17,107

Increase (decrease) in cash and cash equivalents
(16,027
)
 
(3,316
)
 
(12,711
)
Cash and cash equivalents January 1
41,558

 
24,920

 
16,638

Cash and cash equivalents September 30
$
25,531

 
$
21,604

 
$
3,927

Market Risk
Our primary market risks are interest rate risk and liquidity risk. We have no significant foreign exchange risk and do not utilize interest rate swaps or derivatives, except for interest rate locks and forward loan commitments, in the management of IRR. Any changes in foreign exchange rates or commodity prices would have an insignificant impact on our interest income and cash flows.
IRR is the exposure of our net interest income to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. IRR is the fundamental method by which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to our earnings and capital.
The FRB has adopted a policy requiring us to effectively manage the various risks that can have a material impact on our safety and soundness. The risks include credit, interest rate, liquidity, operational, and reputational. We have policies, procedures, and internal controls for measuring and managing these risks. Specifically, our Funds Management policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long term assets, limiting the mismatch in repricing opportunity of assets and liabilities, and the frequency of measuring and reporting to our Board.
The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield curves, interest rate relationships, and loan prepayments. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies.

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Our interest rate sensitivity is estimated by first forecasting the next 12 and 24 months of net interest income under an assumed environment of a constant balance sheet and constant market interest rates (base case). We then compare the results of various simulation analyses to the base case. At September 30, 2014, we projected the change in net interest income during the next 12 and 24 months assuming market interest rates were to immediately decrease by 100 basis points and increase by 100, 200, 300, and 400 basis points in a parallel fashion over the entire yield curve during the same time period. We did not project scenarios showing decreases in interest rates beyond 100 basis points as this is considered extremely unlikely given current interest rate levels. These projections were based on our assets and liabilities remaining static over the next 12 and 24 months, while factoring in probable calls and prepayments of certain investment securities and real estate residential and consumer loans. While it is extremely unlikely that interest rates would immediately increase to these levels, we feel that these extreme scenarios help us identify potential gaps and mismatches in the repricing characteristics of assets and liabilities. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits.
The following table summarizes our interest rate sensitivity for the:
 
12 Months Ending September 30, 2015
Immediate basis point change assumption (short-term)
(100)
 
0
 
100
 
200
 
300
 
400
Percent change in net interest income vs. constant rates
(1.03
)%
 

 
(1.24
)%
 
(2.60
)%
 
(5.01
)%
 
(7.40
)%
 
24 Months Ending September 30, 2016
Immediate basis point change assumption (short-term)
(100)
 
0
 
100
 
200
 
300
 
400
Percent change in net interest income vs. constant rates
(1.11
)%
 

 
(1.67
)%
 
(0.87
)%
 
(1.70
)%
 
(3.15
)%
 
12 Months Ending December 31, 2014
Immediate basis point change assumption (short-term)
(100)
 
0
 
100
 
200
 
300
 
400
Percent change in net interest income vs. constant rates
(2.85
)%
 

 
0.25
%
 
(0.28
)%
 
(0.99
)%
 
(2.16
)%
 
24 Months Ending December 31, 2015
Immediate basis point change assumption (short-term)
(100)
 
0
 
100
 
200
 
300
 
400
Percent change in net interest income vs. constant rates
(3.24
)%
 

 
0.04
%
 
0.29
%
 
0.41
%
 
(0.35
)%
The following tables provide information about assets and liabilities that are sensitive to changes in interest rates as of September 30, 2014 and December 31, 2013. The principal amounts of investments, loans, other interest earning assets, borrowings, and time deposits maturing were calculated based on the contractual maturity dates. Estimated cash flows for savings and NOW accounts are based on our estimated deposit decay rates.

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September 30, 2014
 
2015
 
2016
 
2017
 
2018
 
2019
 
Thereafter
 
Total
 
Fair Value
Rate sensitive assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest bearing assets
$
3,580

 
$

 
$
100

 
$

 
$

 
$

 
$
3,680

 
$
3,680

Average interest rates
0.34
%
 

 
0.35
%
 

 

 

 
0.34
%
 
 
Trading securities
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

Average interest rates

 

 

 

 

 

 

 
 
AFS securities
$
118,904

 
$
100,245

 
$
70,790

 
$
53,291

 
$
47,563

 
$
184,287

 
$
575,080

 
$
575,080

Average interest rates
2.28
%
 
2.13
%
 
2.48
%
 
2.40
%
 
2.48
%
 
2.55
%
 
2.39
%
 
 
Fixed interest rate loans (1)
$
106,995

 
$
99,861

 
$
122,666

 
$
97,838

 
$
73,782

 
$
146,046

 
$
647,188

 
$
646,966

Average interest rates
5.23
%
 
4.90
%
 
4.55
%
 
4.33
%
 
4.46
%
 
4.26
%
 
4.61
%
 
 
Variable interest rate loans (1)
$
69,853

 
$
27,196

 
$
20,875

 
$
14,689

 
$
14,727

 
$
27,771

 
$
175,111

 
$
175,111

Average interest rates
7.06
%
 
4.01
%
 
3.92
%
 
3.41
%
 
3.31
%
 
3.90
%
 
5.09
%
 
 
Rate sensitive liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Borrowed funds
$
150,421

 
$
20,000

 
$
30,000

 
$
40,017

 
$
20,000

 
$
30,000

 
$
290,438

 
$
293,881

Average interest rates
0.32
%
 
1.69
%
 
1.95
%
 
2.35
%
 
3.10
%
 
2.75
%
 
1.30
%
 
 
Savings and NOW accounts
$
41,131

 
$
37,074

 
$
33,300

 
$
29,942

 
$
26,951

 
$
293,288

 
$
461,686

 
$
461,686

Average interest rates
0.12
%
 
0.12
%
 
0.12
%
 
0.12
%
 
0.12
%
 
0.12
%
 
0.12
%
 
 
Fixed interest rate certificates of deposit
$
219,928

 
$
76,618

 
$
61,472

 
$
56,442

 
$
22,813

 
$
6,200

 
$
443,473

 
$
444,032

Average interest rates
0.93
%
 
1.69
%
 
1.57
%
 
1.35
%
 
1.45
%
 
4.61
%
 
1.28
%
 
 
Variable interest rate certificates of deposit
$
748

 
$
349

 
$

 
$

 
$

 
$

 
$
1,097

 
$
1,097

Average interest rates
0.40
%
 
0.40
%
 

 

 

 

 
0.40
%
 
 

December 31, 2013
 
2014
 
2015
 
2016
 
2017
 
2018
 
Thereafter
 
Total
 
Fair Value
Rate sensitive assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest bearing assets
$
19,903

 
$
480

 
$

 
$

 
$

 
$

 
$
20,383

 
$
20,385

Average interest rates
0.25
%
 
1.15
%
 

 

 

 

 
0.27
%
 
 
Trading securities
$
525

 
$

 
$

 
$

 
$

 
$

 
$
525

 
$
525

Average interest rates
2.77
%
 

 

 

 

 

 
2.77
%
 
 
AFS securities
$
131,892

 
$
73,723

 
$
63,190

 
$
52,078

 
$
37,972

 
$
153,207

 
$
512,062

 
$
512,062

Average interest rates
2.26
%
 
2.23
%
 
2.42
%
 
2.48
%
 
2.48
%
 
2.80
%
 
2.48
%
 
 
Fixed interest rate loans (1)
$
115,183

 
$
94,841

 
$
91,140

 
$
118,479

 
$
85,448

 
$
134,614

 
$
639,705

 
$
639,914

Average interest rates
5.31
%
 
5.17
%
 
4.93
%
 
4.53
%
 
4.33
%
 
4.33
%
 
4.75
%
 
 
Variable interest rate loans (1)
$
69,036

 
$
29,460

 
$
20,332

 
$
14,208

 
$
15,699

 
$
19,597

 
$
168,332

 
$
168,332

Average interest rates
4.76
%
 
3.90
%
 
4.06
%
 
3.36
%
 
3.35
%
 
3.99
%
 
4.19
%
 
 
Rate sensitive liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Borrowed funds
$
126,950

 
$
32,376

 
$
10,000

 
$
30,000

 
$
40,000

 
$
40,000

 
$
279,326

 
$
283,060

Average interest rates
0.43
%
 
0.86
%
 
2.15
%
 
1.95
%
 
2.35
%
 
3.02
%
 
1.35
%
 
 
Savings and NOW accounts
$
47,000

 
$
33,569

 
$
30,200

 
$
27,198

 
$
24,522

 
$
272,837

 
$
435,326

 
$
435,326

Average interest rates
0.19
%
 
0.12
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.12
%
 
 
Fixed interest rate certificates of deposit
$
206,514

 
$
81,038

 
$
58,627

 
$
46,336

 
$
39,214

 
$
17,144

 
$
448,873

 
$
451,664

Average interest rates
0.89
%
 
1.93
%
 
1.95
%
 
1.63
%
 
1.34
%
 
1.66
%
 
1.36
%
 
 
Variable interest rate certificates of deposit
$
764

 
$
375

 
$

 
$

 
$

 
$

 
$
1,139

 
$
1,139

Average interest rates
0.04
%
 
0.40
%
 

 

 

 

 
0.16
%
 
 
 (1) The fair value reported is exclusive of the allocation of the ALLL.
We do not believe that there has been a material change in the nature or categories of our primary market risk exposure, or the particular markets that present the primary risk of loss. As of the date of this report, we do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term. As of the date of this report, we do not expect to make material changes in those methods in the near term. We may change those methods in the future to adapt to changes in circumstances or to implement new techniques.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk
The information presented in the section captioned “Market Risk” in Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.
Item 4. Controls and Procedures
DISCLOSURE CONTROLS AND PROCEDURES
We carried out an evaluation, under the supervision and with the participation of the Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15(d)-15(e) under the Exchange Act) as of September 30, 2014, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as of September 30, 2014, 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 effect, our internal control over financial reporting.


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PART II – OTHER INFORMATION
Item 1. Legal Proceedings
We are not involved in any material legal proceedings. We are involved in ordinary, routine litigation incidental to our business; however, no such routine proceedings are expected to result in any material adverse effect on operations, earnings, financial condition, or cash flows.
Item 1A. Risk Factors
There have been no material changes to the risk factors disclosed in Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2013.
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 October 22, 2014, to allow for the repurchase of an additional 150,000 shares of common stock after that date. These authorizations do not have expiration dates. As shares are repurchased under this plan, they are retired and revert back to the status of authorized, but unissued shares.
The following table provides information for the three month period ended September 30, 2014, with respect to this plan:
 
Shares Repurchased
 
Total Number of Shares Purchased as Part of Publicly Announced Plan or Program
 
Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs

Number
 
Average Price
Per Share
 
 
Balance, June 30
 
 
 
 
 
 
66,812

July 1 - 31
9,399

 
$
22.02

 
9,399

 
57,413

August 1 - 31
16,464

 
22.11

 
16,464

 
40,949

September 1 - 30
14,233

 
23.33

 
14,233

 
26,716

Balance, September 30
40,096

 
$
22.52

 
40,096

 
26,716


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Item 6. Exhibits
(a)
 
Exhibits
 
 
 
31(a)
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Executive Officer
 
 
 
31(b)
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Financial Officer
 
 
 
32
 
Section 1350 Certification of Principal Executive Officer and Principal Financial Officer
 
 
 
101.1*
 
101.INS (XBRL Instance Document)
 
 
 
 
 
101.SCH (XBRL Taxonomy Extension Schema Document)
 
 
 
 
 
101.CAL (XBRL Calculation Linkbase Document)
 
 
 
 
 
101.LAB (XBRL Taxonomy Label Linkbase Document)
 
 
 
 
 
101.DEF (XBRL Taxonomy Linkbase Document)
 
 
 
 
 
101.PRE (XBRL Taxonomy Presentation Linkbase Document)
In accordance with Rule 406T of Regulations S-T, the XBRL related information shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Isabella Bank Corporation
 
 
 
 
Date:
November 7, 2014
 
 
/s/ Jae A. Evans
 
 
 
 
Jae A. Evans
 
 
 
 
Chief Executive Officer
 
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
November 7, 2014
 
 
/s/ Dennis P. Angner
 
 
 
 
Dennis P. Angner
 
 
 
 
President, Chief Financial Officer
 
 
 
 
(Principal Financial Officer, Principal Accounting Officer)

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