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ISABELLA BANK Corp - Quarter Report: 2016 March (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2016
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 common shares outstanding of the registrant’s Common Stock (no par value) was 7,839,650 as of May 5, 2016.


Table of Contents

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

2

Table of Contents

Forward Looking Statements
This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward looking statements to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, and are included in this statement for purposes of these safe harbor provisions. Forward looking statements, which are based on certain assumptions and describe future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, monetary and fiscal policy, the quality or composition of the loan or investment portfolios, demand for loan products, fluctuation in the value of collateral securing our loan portfolio, deposit flows, competition, demand for financial services in our market area, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward looking statements and undue reliance should not be placed on such statements. Further information concerning our business, including additional factors that could materially affect our financial results, is included in our filings with the SEC.
Glossary of Acronyms and Abbreviations
The acronyms and abbreviations identified below may be used throughout this Quarterly Report on Form 10-Q, or in our other SEC filings. You may find it helpful to refer back to this page while reading this report.
AFS: Available-for-sale
 
GAAP: U.S. generally accepted accounting principles
ALLL: Allowance for loan and lease losses
 
GLB Act: Gramm-Leach-Bliley Act of 1999
AOCI: Accumulated other comprehensive income
 
IFRS: International Financial Reporting Standards
ASC: FASB Accounting Standards Codification
 
IRR: Interest rate risk
ASU: FASB Accounting Standards Update
 
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
 
OMSR: Originated mortgage servicing rights
ESOP: Employee Stock Ownership Plan
 
OREO: Other real estate owned
Exchange Act: Securities Exchange Act of 1934
 
OTTI: Other-than-temporary impairment
FASB: Financial Accounting Standards Board
 
PBO: Projected benefit obligation
FDI Act: Federal Deposit Insurance Act
 
PCAOB: Public Company Accounting Oversight Board
FDIC: Federal Deposit Insurance Corporation
 
Rabbi Trust: A trust established to fund the Directors Plan
FFIEC: Federal Financial Institutions Examinations Council
 
SEC: U.S. Securities & 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
 
 

3

Table of Contents

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

March 31
2016
 
December 31
2015
ASSETS
 
 
 
Cash and cash equivalents
 
 
 
Cash and demand deposits due from banks
$
16,670

 
$
18,810

Interest bearing balances due from banks
11,457

 
2,759

Total cash and cash equivalents
28,127

 
21,569

AFS securities (amortized cost of $636,797 in 2016 and $654,348 in 2015)
649,859

 
660,136

Mortgage loans AFS
1,240

 
1,187

Loans
 
 
 
Commercial
470,305

 
448,381

Agricultural
115,686

 
115,911

Residential real estate
249,318

 
251,501

Consumer
34,982

 
34,699

Gross loans
870,291

 
850,492

Less allowance for loan and lease losses
7,500

 
7,400

Net loans
862,791

 
843,092

Premises and equipment
28,269

 
28,331

Corporate owned life insurance policies
26,611

 
26,423

Accrued interest receivable
6,995

 
6,269

Equity securities without readily determinable fair values
22,226

 
22,286

Goodwill and other intangible assets
48,785

 
48,828

Other assets
6,915

 
9,991

TOTAL ASSETS
$
1,681,818

 
$
1,668,112

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits
 
 
 
Noninterest bearing
$
183,820

 
$
191,376

NOW accounts
215,327

 
212,666

Certificates of deposit under $100 and other savings
534,022

 
521,793

Certificates of deposit over $100
240,338

 
238,728

Total deposits
1,173,507

 
1,164,563

Borrowed funds
307,896

 
309,732

Accrued interest payable and other liabilities
10,168

 
9,846

Total liabilities
1,491,571

 
1,484,141

Shareholders’ equity
 
 
 
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,809,079 shares (including 15,764 shares held in the Rabbi Trust) in 2016 and 7,799,867 shares (including 19,401 shares held in the Rabbi Trust) in 2015
139,501

 
139,198

Shares to be issued for deferred compensation obligations
4,623

 
4,592

Retained earnings
41,105

 
39,960

Accumulated other comprehensive income
5,018

 
221

Total shareholders’ equity
190,247

 
183,971

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,681,818

 
$
1,668,112



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

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Table of Contents

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

Three Months Ended 
 March 31
 
2016
 
2015
Interest income
 
 
 
Loans, including fees
$
9,038

 
$
9,025

AFS securities
 
 
 
Taxable
2,400

 
2,107

Nontaxable
1,485

 
1,482

Federal funds sold and other
158

 
139

Total interest income
13,081

 
12,753

Interest expense
 
 
 
Deposits
1,399

 
1,466

Borrowings
1,215

 
1,022

Total interest expense
2,614

 
2,488

Net interest income
10,467

 
10,265

Provision for loan losses
156

 
(726
)
Net interest income after provision for loan losses
10,311

 
10,991

Noninterest income
 
 
 
Service charges and fees
1,213

 
1,163

Net gain on sale of mortgage loans
82

 
149

Earnings on corporate owned life insurance policies
188

 
187

Other
740

 
629

Total noninterest income
2,223

 
2,128

Noninterest expenses
 
 
 
Compensation and benefits
4,788

 
4,766

Furniture and equipment
1,468

 
1,314

Occupancy
758

 
721

Other
2,066

 
1,874

Total noninterest expenses
9,080

 
8,675

Income before federal income tax expense
3,454

 
4,444

Federal income tax expense
437

 
771

NET INCOME
$
3,017

 
$
3,673

Earnings per common share
 
 
 
Basic
$
0.39

 
$
0.47

Diluted
$
0.38

 
$
0.46

Cash dividends per common share
$
0.24

 
$
0.23








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

5

Table of Contents

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

Three Months Ended 
 March 31
 
2016
 
2015
Net income
$
3,017

 
$
3,673

Unrealized gains on AFS securities arising during the period
7,274

 
4,356

Tax effect (1)
(2,477
)
 
(1,366
)
Other comprehensive income, net of tax
4,797

 
2,990

Comprehensive income
$
7,814

 
$
6,663

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


























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

6

Table of Contents

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

Common Shares
Outstanding
 
Amount
 
Common Shares to be
Issued for
Deferred
Compensation
Obligations
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Totals
Balance, January 1, 2015
7,776,274

 
$
138,755

 
$
4,242

 
$
32,103

 
$
(506
)
 
$
174,594

Comprehensive income (loss)

 

 

 
3,673

 
2,990

 
6,663

Issuance of common stock
41,217

 
945

 

 

 

 
945

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

 
123

 
(123
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
146

 

 

 
146

Common stock purchased for deferred compensation obligations

 
(100
)
 

 

 

 
(100
)
Common stock repurchased pursuant to publicly announced repurchase plan
(35,671
)
 
(820
)
 

 

 

 
(820
)
Cash dividends paid ($0.23 per common share)

 

 

 
(1,775
)
 

 
(1,775
)
Balance, March 31, 2015
7,781,820

 
$
138,903

 
$
4,265

 
$
34,001

 
$
2,484

 
$
179,653

Balance, January 1, 2016
7,799,867

 
$
139,198

 
$
4,592

 
$
39,960

 
$
221

 
$
183,971

Comprehensive income (loss)

 

 

 
3,017

 
4,797

 
7,814

Issuance of common stock
37,465

 
1,072

 

 

 

 
1,072

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

 
127

 
(127
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
158

 

 

 
158

Common stock purchased for deferred compensation obligations

 
(97
)
 

 

 

 
(97
)
Common stock repurchased pursuant to publicly announced repurchase plan
(28,253
)
 
(799
)
 

 

 

 
(799
)
Cash dividends paid ($0.24 per common share)

 

 

 
(1,872
)
 

 
(1,872
)
Balance, March 31, 2016
7,809,079

 
$
139,501

 
$
4,623

 
$
41,105

 
$
5,018

 
$
190,247















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

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Table of Contents

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

Three Months Ended 
 March 31
 
2016
 
2015
OPERATING ACTIVITIES
 
 
 
Net income
$
3,017

 
$
3,673

Reconciliation of net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
156

 
(726
)
Depreciation
727

 
654

Amortization of OMSR
64

 
70

Amortization of acquisition intangibles
43

 
38

Net amortization of AFS securities
705

 
478

Net gain on sale of mortgage loans
(82
)
 
(149
)
Increase in cash value of corporate owned life insurance policies
(188
)
 
(187
)
Share-based payment awards under equity compensation plan
158

 
146

Origination of loans held-for-sale
(4,499
)
 
(11,209
)
Proceeds from loan sales
4,528

 
11,202

Net changes in operating assets and liabilities which provided (used) cash:
 
 
 
Accrued interest receivable
(726
)
 
(947
)
Other assets
450

 
(207
)
Accrued interest payable and other liabilities
322

 
(810
)
Net cash provided by (used in) operating activities
4,675

 
2,026

INVESTING ACTIVITIES
 
 
 
Activity in AFS securities
 
 
 
Maturities, calls, and principal payments
19,452

 
14,419

Purchases
(2,606
)
 
(48,215
)
Net loan principal (originations) collections
(19,944
)
 
18,149

Proceeds from sales of foreclosed assets
234

 
302

Purchases of premises and equipment
(665
)
 
(943
)
Purchases of corporate owned life insurance policies

 
(500
)
Net cash provided by (used in) investing activities
(3,529
)
 
(16,788
)

8

Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
 
Three Months Ended 
 March 31
 
2016
 
2015
FINANCING ACTIVITIES
 
 
 
Net increase (decrease) in deposits
$
8,944

 
$
24,171

Net increase (decrease) in borrowed funds
(1,836
)
 
(6,388
)
Cash dividends paid on common stock
(1,872
)
 
(1,775
)
Proceeds from issuance of common stock
1,072

 
945

Common stock repurchased
(799
)
 
(820
)
Common stock purchased for deferred compensation obligations
(97
)
 
(100
)
Net cash provided by (used in) financing activities
5,412

 
16,033

Increase (decrease) in cash and cash equivalents
6,558

 
1,271

Cash and cash equivalents at beginning of period
21,569

 
19,906

Cash and cash equivalents at end of period
$
28,127

 
$
21,177

SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Interest paid
$
2,574

 
$
2,462

Income taxes paid

 
1,393

SUPPLEMENTAL NONCASH INFORMATION:
 
 
 
Transfers of loans to foreclosed assets
$
89

 
$
134





















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

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Table of Contents

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Dollars in thousands except per share amounts)
Note 1 – Basis of Presentation
As used in these notes as well as in Management's Discussion and Analysis of Financial Condition and Results of Operations, references to “Isabella,” the “Corporation”, “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiaries. Isabella Bank Corporation refers solely to the parent holding company, and Isabella Bank or the “Bank” refer to Isabella Bank Corporation’s subsidiary, Isabella Bank.
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2015.
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, 2015.
Reclassifications: Certain amounts reported in the 2015 consolidated financial statements have been reclassified to conform with the 2016 presentation.
Restatements: In this Quarterly Report on Form 10-Q, certain prior period financial information has been restated due to an accounting correction. Impacted sections of the Consolidated Financial Statements include:
1.
Consolidated Statements of Income for the three month period ended March 31, 2015 and Consolidated Statements of Cash Flows for the three month period ended March 31, 2015; and
2.
Notes to Consolidated Financial Statements for the three month period ended March 31, 2015.
On the Consolidated Statements of Income, the effects of the restatement reduced loan interest and fee income by $659 and compensation and benefits were reduced by $659 for the three months ended March 31, 2015. The restatement did not impact net income for the three month period ended March 31, 2015.
All amounts in this Quarterly Report on Form 10-Q affected by the restatement adjustments reflect such amounts as restated. For information related to the restatement, refer to our Annual Report on Form 10-K for the year ended December 31, 2015.
Note 2 – Computation of Earnings Per Common Share
Basic earnings per common share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued relate solely to outstanding shares in the Directors Plan.
 
Three Months Ended 
 March 31

2016
 
2015
Average number of common shares outstanding for basic calculation
7,795,294

 
7,773,428

Average potential effect of common shares in the Directors Plan (1)
184,461

 
177,001

Average number of common shares outstanding used to calculate diluted earnings per common share
7,979,755

 
7,950,429

Net income
$
3,017

 
$
3,673

Earnings per common share
 
 
 
Basic
$
0.39

 
$
0.47

Diluted
$
0.38

 
$
0.46

(1) 
Exclusive of shares held in the Rabbi Trust

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Table of Contents

Note 3 – Accounting Standards Updates
Pending Accounting Standards Updates
ASU No. 2016-01: Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Liabilities
In January 2016, ASU No. 2016-01 set forth the following: 1) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income; 2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment and when an impairment exists, an entity is required to measure the investment at fair value; 3) for public entities, eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; 4) for public entities, requires the use of exit price notion when measuring the fair value of financial instruments for disclosure purposes; 5) requires an entity to present separately in other comprehensive income, the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; 6) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; and 7) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2017 and is expected to have an impact on financial statement disclosures due to existing equity investments.
ASU No. 2016-02: “Leases (Topic 842)
In February 2016, ASU No. 2016-02 was issued to create Topic 842 - Leases which will require recognition of lease assets and lease liabilities on the balance sheet for leases previously classified as operating leases. Accounting guidance is set forth for both lessee and lessor accounting. Under lessee accounting, a lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.
For finance leases, a lessee is required to do the following: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position; 2) recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of comprehensive income; and 3) classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows. For operating leases, a lessee is required to do the following: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position; 2) recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis; and 3) classify all cash payments within operating activities in the statement of cash flows.
The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2018 and is not expected to have a significant impact on our operations or financial statement disclosures.
ASU No. 2016-07: “Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition of the Equity Method of Accounting
In March 2016, ASU No. 2016-07 eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. Additionally, the update requires that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2016 and is not expected to have a significant impact on our operations or financial statement disclosures.

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ASU No. 2016-09: “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
In March 2016, ASU No. 2016-09 updated several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2016 and is not expected to have a significant impact on our operations or financial statement disclosures.
Note 4 – AFS Securities
The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:
 
March 31, 2016

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
24,383

 
$
57

 
$
12

 
$
24,428

States and political subdivisions
222,835

 
8,649

 
12

 
231,472

Auction rate money market preferred
3,200

 

 
393

 
2,807

Preferred stocks
3,800

 

 
454

 
3,346

Mortgage-backed securities
255,009

 
3,409

 
134

 
258,284

Collateralized mortgage obligations
127,570

 
2,206

 
254

 
129,522

Total
$
636,797

 
$
14,321

 
$
1,259

 
$
649,859

 
December 31, 2015

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
24,407

 
$
13

 
$
75

 
$
24,345

States and political subdivisions
224,752

 
7,511

 
46

 
232,217

Auction rate money market preferred
3,200

 

 
334

 
2,866

Preferred stocks
3,800

 

 
501

 
3,299

Mortgage-backed securities
264,109

 
1,156

 
1,881

 
263,384

Collateralized mortgage obligations
134,080

 
1,136

 
1,191

 
134,025

Total
$
654,348

 
$
9,816

 
$
4,028

 
$
660,136

The amortized cost and fair value of AFS securities by contractual maturity at March 31, 2016 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
$

 
$
24,029

 
$
354

 
$

 
$

 
$
24,383

States and political subdivisions
31,685

 
66,833

 
91,042

 
33,275

 

 
222,835

Auction rate money market preferred

 

 

 

 
3,200

 
3,200

Preferred stocks

 

 

 

 
3,800

 
3,800

Mortgage-backed securities

 

 

 

 
255,009

 
255,009

Collateralized mortgage obligations

 

 

 

 
127,570

 
127,570

Total amortized cost
$
31,685

 
$
90,862

 
$
91,396

 
$
33,275

 
$
389,579

 
$
636,797

Fair value
$
31,742


$
93,332


$
96,031


$
34,795


$
393,959

 
$
649,859

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.

12

Table of Contents

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.
Information pertaining to AFS securities with gross unrealized losses at March 31, 2016 and December 31, 2015, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
 
March 31, 2016
 
Less Than Twelve Months
 
Twelve Months or More
 
 

Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total
Unrealized
Losses
Government sponsored enterprises
$
12

 
$
8,985

 
$

 
$

 
$
12

States and political subdivisions
1

 
576

 
11

 
681

 
12

Auction rate money market preferred

 

 
393

 
2,807

 
393

Preferred stocks

 

 
454

 
3,346

 
454

Mortgage-backed securities
12

 
6,955

 
122

 
25,526

 
134

Collateralized mortgage obligations

 

 
254

 
30,281

 
254

Total
$
25

 
$
16,516

 
$
1,234

 
$
62,641

 
$
1,259

Number of securities in an unrealized loss position:
 
 
4

 
 
 
17

 
21

 
December 31, 2015
 
Less Than Twelve Months
 
Twelve Months or More
 
 

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

 
$

 
$
75

 
$
4,925

 
$
75

States and political subdivisions
14

 
3,355

 
32

 
2,623

 
46

Auction rate money market preferred

 

 
334

 
2,866

 
334

Preferred stocks

 

 
501

 
3,299

 
501

Mortgage-backed securities
882

 
131,885

 
999

 
37,179

 
1,881

Collateralized mortgage obligations
415

 
53,441

 
776

 
26,717

 
1,191

Total
$
1,311

 
$
188,681

 
$
2,717

 
$
77,609

 
$
4,028

Number of securities in an unrealized loss position:
 
 
36

 
 
 
26

 
62

As of March 31, 2016 and December 31, 2015, we conducted an analysis to determine whether any AFS securities currently in an unrealized loss position should be other-than-temporarily impaired. Such analyses considered, among other factors, the following criteria:
Has the value of the investment declined more than what is deemed to be reasonable based on a risk and maturity adjusted discount rate?
Is the investment credit rating below investment grade?
Is it probable the issuer will be unable to pay the amount when due?
Is it more likely than not that we will have to sell the security before recovery of its cost basis?
Has the duration of the investment been extended?
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 any AFS securities in an unrealized loss position before recovery of their cost basis, we do not believe that the values of any AFS securities were other-than-temporarily impaired as of March 31, 2016 or December 31, 2015.

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Table of Contents

Note 5 – Loans and ALLL
We grant commercial, agricultural, residential real estate, and consumer loans to customers situated primarily in Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties in Michigan. The ability of the borrowers to honor their repayment obligations is often dependent upon the real estate, agricultural, manufacturing, retail, gaming, tourism, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees; a portion of loans are unsecured.
Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and any deferred fees or costs. Interest income is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the level yield method.
The accrual of interest on commercial, agricultural, and residential real estate loans is discontinued at the time the loan is 90 days or more past due unless the credit is well-secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful.
For loans that are placed on nonaccrual status or charged-off, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the ALLL. Loans may be returned to accrual status after six months of continuous performance.
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 dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of direct credit exposure to any one borrower to $15,000. Borrowers with direct credit needs of more than $15,000 are serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans commonly require loan-to-value limits of 80% or less. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, and property and equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we require annual financial statements, prepare cash flow analyses, and review credit reports.
We offer adjustable rate mortgages, construction loans, and fixed rate residential real estate loans which have amortization periods up to a maximum of 30 years. We consider the anticipated direction of interest rates, balance sheet duration, the sensitivity of our balance sheet to changes in interest rates, and overall loan demand to determine whether or not to sell fixed rate loans to Freddie Mac.
Our lending policies generally limit the maximum loan-to-value ratio on residential real estate loans to 97% 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%.
Underwriting criteria for residential real estate loans include:
Evaluation of the borrower’s ability to make monthly payments.
Evaluation of the value of the property securing the loan.
Ensuring the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower’s gross income.
Ensuring all debt servicing does not exceed 36% of income.
Verification of acceptable credit reports.
Verification of employment, income, and financial information.

Appraisals are performed by independent appraisers and reviewed for appropriateness. All mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market underwriting system; loans in excess of $500 require the approval of our Internal Loan Committee, the Executive Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors.

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Table of Contents

Consumer loans include secured and unsecured personal loans. Loans are amortized for a period of up to 12 years based on the age and value of the underlying collateral. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market.
The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL.
The appropriateness of the ALLL is evaluated on a quarterly basis and is based upon a periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. Specific allocations for impaired loans are primarily determined based on the difference between the loan’s outstanding balance 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 are calculated at the loan class and segment levels based on a migration analysis of the loan portfolio over the preceding five years. 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 March 31, 2016

Commercial

Agricultural

Residential Real Estate

Consumer

Unallocated

Total
January 1, 2016
$
2,171


$
329


$
3,330


$
522


$
1,048


$
7,400

Charge-offs
(16
)



(241
)

(84
)



(341
)
Recoveries
89


92


50


54




285

Provision for loan losses
177


(85
)

(9
)

48


25


156

March 31, 2016
$
2,421


$
336


$
3,130


$
540


$
1,073


$
7,500

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

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
908

 
$

 
$
1,823

 
$

 
$

 
$
2,731

Collectively evaluated for impairment
1,513

 
336

 
1,307

 
540

 
1,073

 
4,769

Total
$
2,421

 
$
336

 
$
3,130

 
$
540

 
$
1,073

 
$
7,500

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
6,840

 
$
4,065

 
$
10,088

 
$
34

 
 
 
$
21,027

Collectively evaluated for impairment
463,465

 
111,621

 
239,230

 
34,948

 
 
 
849,264

Total
$
470,305

 
$
115,686

 
$
249,318

 
$
34,982

 
 
 
$
870,291


15

Table of Contents

 
Allowance for Loan Losses
 
Three Months Ended March 31, 2015

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
January 1, 2015
$
3,821

 
$
216

 
$
4,235

 
$
645

 
$
1,183

 
$
10,100

Charge-offs
(17
)
 

 
(50
)
 
(93
)
 

 
(160
)
Recoveries
213

 
72

 
33

 
68

 

 
386

Provision for loan losses
(209
)
 
(82
)
 
(490
)
 
91

 
(36
)
 
(726
)
March 31, 2015
$
3,808

 
$
206

 
$
3,728

 
$
711

 
$
1,147

 
$
9,600

 
Allowance for Loan Losses and Recorded Investment in Loans
 
December 31, 2015

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
829

 
$
2

 
$
1,989

 
$

 
$

 
$
2,820

Collectively evaluated for impairment
1,342

 
327

 
1,341

 
522

 
1,048

 
4,580

Total
$
2,171

 
$
329

 
$
3,330

 
$
522

 
$
1,048

 
$
7,400

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
7,969

 
$
4,068

 
$
10,266

 
$
35

 
 
 
$
22,338

Collectively evaluated for impairment
440,412

 
111,843

 
241,235

 
34,664

 
 
 
828,154

Total
$
448,381


$
115,911

 
$
251,501

 
$
34,699

 
 
 
$
850,492

The following table displays the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit risk ratings as of:
 
March 31, 2016
 
Commercial
 
Agricultural

Real Estate
 
Other
 
Total
 
Real Estate
 
Other
 
Total
Rating
 
 
 
 
 
 
 
 
 
 

1 - Excellent
$

 
$
729

 
$
729

 
$

 
$

 
$

2 - High quality
10,638

 
9,950

 
20,588

 
4,469

 
1,608

 
6,077

3 - High satisfactory
99,591

 
25,599

 
125,190

 
27,867

 
11,771

 
39,638

4 - Low satisfactory
238,565

 
72,438

 
311,003

 
37,292

 
21,809

 
59,101

5 - Special mention
4,069

 
483

 
4,552

 
3,742

 
4,266

 
8,008

6 - Substandard
7,834

 
241

 
8,075

 
2,113

 
603

 
2,716

7 - Vulnerable
168

 

 
168

 
146

 

 
146

8 - Doubtful

 

 

 

 

 

Total
$
360,865

 
$
109,440

 
$
470,305

 
$
75,629

 
$
40,057

 
$
115,686


16

Table of Contents

 
December 31, 2015
 
Commercial
 
Agricultural

Real Estate
 
Other
 
Total
 
Real Estate
 
Other
 
Total
Rating
 
 
 
 
 
 
 
 
 
 
 
1 - Excellent
$

 
$
499

 
$
499

 
$

 
$

 
$

2 - High quality
7,397

 
11,263

 
18,660

 
4,647

 
2,150

 
6,797

3 - High satisfactory
99,136

 
29,286

 
128,422

 
28,886

 
13,039

 
41,925

4 - Low satisfactory
222,431

 
62,987

 
285,418

 
37,279

 
22,166

 
59,445

5 - Special mention
4,501

 
473

 
4,974

 
3,961

 
1,875

 
5,836

6 - Substandard
9,941

 
256

 
10,197

 
1,623

 
139

 
1,762

7 - Vulnerable
211

 

 
211

 
146

 

 
146

8 - Doubtful

 

 

 

 

 

Total
$
343,617

 
$
104,764

 
$
448,381

 
$
76,542

 
$
39,369

 
$
115,911

Internally assigned credit risk ratings are reviewed, at a minimum, when loans are renewed or when management has knowledge of improvements or deterioration of the credit quality of individual credits. Descriptions of the internally assigned credit risk ratings for commercial and agricultural loans are as follows:
1. EXCELLENT – Substantially Risk Free
Credit has strong financial condition and solid earnings history, characterized by:
High liquidity, strong cash flow, low leverage.
Unquestioned ability to meet all obligations when due.
Experienced management, with management succession in place.
Secured by cash.
2. HIGH QUALITY – Limited Risk
Credit with sound financial condition and a positive trend in earnings supplemented by:
Favorable liquidity and leverage ratios.
Ability to meet all obligations when due.
Management with successful track record.
Steady and satisfactory earnings history.
If loan is secured, collateral is of high quality and readily marketable.
Access to alternative financing.
Well defined primary and secondary source of repayment.
If supported by guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident.
3. HIGH SATISFACTORY – Reasonable Risk
Credit with satisfactory financial condition and further characterized by:
Working capital adequate to support operations.
Cash flow sufficient to pay debts as scheduled.
Management experience and depth appear favorable.
Loan performing according to terms.
If loan is secured, collateral is acceptable and loan is fully protected.

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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 status. Risk of loss is being evaluated and exit strategy options are under review. Other characteristics that may apply:
Insufficient cash flow to service debt.
Minimal or no payments being received.
Limited options available to avoid the collection process.
Transition status, expect action will take place to collect loan without immediate progress being made.

18

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

30-59
Days
 
60-89
Days
 
90 Days
or More
 
Nonaccrual
 
 
Current
 
Total
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
859

 
$

 
$
55

 
$
168

 
$
1,082

 
$
359,783

 
$
360,865

Commercial other
231

 

 

 

 
231

 
109,209

 
109,440

Total commercial
1,090

 

 
55

 
168

 
1,313

 
468,992

 
470,305

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate
629

 

 

 
146

 
775

 
74,854

 
75,629

Agricultural other
79

 

 

 

 
79

 
39,978

 
40,057

Total agricultural
708

 

 

 
146

 
854

 
114,832

 
115,686

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
1,665

 
134

 

 
702

 
2,501

 
199,836

 
202,337

Junior liens
43

 

 

 

 
43

 
8,941

 
8,984

Home equity lines of credit
303

 

 

 

 
303

 
37,694

 
37,997

Total residential real estate
2,011

 
134

 

 
702

 
2,847

 
246,471

 
249,318

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
24

 

 

 

 
24

 
31,500

 
31,524

Unsecured
4

 

 

 

 
4

 
3,454

 
3,458

Total consumer
28

 

 

 

 
28

 
34,954

 
34,982

Total
$
3,837

 
$
134

 
$
55

 
$
1,016

 
$
5,042

 
$
865,249

 
$
870,291


19

Table of Contents

 
December 31, 2015
 
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
$
505

 
$
281

 
$

 
$
211

 
$
997

 
$
342,620

 
$
343,617

Commercial other
18

 

 

 

 
18

 
104,746

 
104,764

Total commercial
523

 
281

 

 
211

 
1,015

 
447,366

 
448,381

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate
196

 
890

 

 
146

 
1,232

 
75,310

 
76,542

Agricultural other

 

 

 

 

 
39,369

 
39,369

Total agricultural
196

 
890

 

 
146

 
1,232

 
114,679

 
115,911

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
1,551

 
261

 

 
429

 
2,241

 
199,622

 
201,863

Junior liens
40

 
8

 

 
6

 
54

 
9,325

 
9,379

Home equity lines of credit
225

 

 

 

 
225

 
40,034

 
40,259

Total residential real estate
1,816

 
269

 

 
435

 
2,520

 
248,981

 
251,501

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
27

 

 

 

 
27

 
30,839

 
30,866

Unsecured
4

 

 

 

 
4

 
3,829

 
3,833

Total consumer
31

 

 

 

 
31

 
34,668

 
34,699

Total
$
2,566

 
$
1,440

 
$

 
$
792

 
$
4,798

 
$
845,694

 
$
850,492

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

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Table of Contents

We do not recognize interest income on impaired loans in nonaccrual status. For impaired loans not classified as nonaccrual, interest income is recognized daily, as earned, according to the terms of the loan agreement and the principal amount outstanding. The following is a summary of information pertaining to impaired loans as of:
 
March 31, 2016
 
December 31, 2015

Outstanding Balance
 
Unpaid Principal Balance
 
Valuation Allowance
 
Outstanding Balance
 
Unpaid Principal Balance
 
Valuation Allowance
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
5,856

 
$
5,976

 
$
906

 
$
5,659

 
$
5,777

 
$
818

Commercial other
96

 
96

 
2

 
8

 
8

 
11

Agricultural real estate

 

 

 

 

 

Agricultural other

 

 

 
335

 
335

 
2

Residential real estate senior liens
9,832

 
10,596

 
1,796

 
9,996

 
10,765

 
1,959

Residential real estate junior liens
135

 
145

 
27

 
143

 
163

 
30

Home equity lines of credit

 

 

 

 

 

Consumer secured

 

 

 

 

 

Total impaired loans with a valuation allowance
15,919

 
16,813

 
2,731

 
16,141

 
17,048

 
2,820

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
807

 
940

 
 
 
2,122

 
2,256

 
 
Commercial other
81

 
92

 
 
 
180

 
191

 
 
Agricultural real estate
3,546

 
3,546

 
 
 
3,549

 
3,549

 
 
Agricultural other
519

 
519

 
 
 
184

 
184

 
 
Home equity lines of credit
121

 
421

 
 
 
127

 
434

 
 
Consumer secured
34

 
34

 
 
 
35

 
35

 
 
Total impaired loans without a valuation allowance
5,108

 
5,552

 
 
 
6,197

 
6,649

 
 
Impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial
6,840

 
7,104

 
908

 
7,969

 
8,232

 
829

Agricultural
4,065

 
4,065

 

 
4,068

 
4,068

 
2

Residential real estate
10,088

 
11,162

 
1,823

 
10,266

 
11,362

 
1,989

Consumer
34

 
34

 

 
35

 
35

 

Total impaired loans
$
21,027

 
$
22,365

 
$
2,731

 
$
22,338

 
$
23,697

 
$
2,820


21

Table of Contents

The following is a summary of information pertaining to impaired loans for the three month periods ended:
 
March 31, 2016
 
March 31, 2015

Average Outstanding Balance
 
Interest Income Recognized
 
Average Outstanding Balance
 
Interest Income Recognized
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
$
5,758

 
$
84

 
$
7,277

 
$
91

Commercial other
52

 
1

 
594

 
10

Agricultural real estate

 

 
44

 
1

Agricultural other
168

 

 

 

Residential real estate senior liens
9,914

 
100

 
11,611

 
118

Residential real estate junior liens
139

 
1

 
258

 
2

Home equity lines of credit

 

 
125

 

Consumer secured

 

 
52

 
1

Total impaired loans with a valuation allowance
16,031


186

 
19,961

 
223

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
1,465

 
19

 
3,405

 
61

Commercial other
131

 
2

 
130

 
3

Agricultural real estate
3,548

 
45

 
1,481

 
21

Agricultural other
352

 
6

 
56

 
1

Home equity lines of credit
124

 
4

 
120

 
6

Consumer secured
35

 
1

 
5

 

Total impaired loans without a valuation allowance
5,655


77

 
5,197

 
92

Impaired loans
 
 
 
 
 
 
 
Commercial
7,406

 
106

 
11,406

 
165

Agricultural
4,068

 
51

 
1,581

 
23

Residential real estate
10,177

 
105

 
12,114

 
126

Consumer
35

 
1

 
57

 
1

Total impaired loans
$
21,686


$
263

 
$
25,158

 
$
315

As of March 31, 2016 and December 31, 2015, we had no commitments to advance 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).

22

Table of Contents

The following is a summary of information pertaining to TDRs granted for the:

Three Months Ended March 31, 2016
 
Three Months Ended March 31, 2015
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
Commercial other

 
$

 
$

 
4

 
$
514

 
$
514

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Senior liens
2

 
26

 
26

 
2

 
238

 
238

Home equity lines of credit

 

 

 
1

 
94

 
94

Total residential real estate
2

 
26

 
26

 
3

 
332

 
332

Consumer unsecured
1

 
2

 
2

 

 

 

Total
3

 
$
28

 
$
28

 
7

 
$
846

 
$
846

The following tables summarize concessions we granted to borrowers in financial difficulty for the:
 
Three Months Ended March 31, 2016
 
Three Months Ended March 31, 2015

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

 
$
183

 
2

 
$
331

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
2

 
26

 

 

 
1

 
49

 
1

 
189

Home equity lines of credit

 

 

 

 

 

 
1

 
94

Total residential real estate
2

 
26

 

 

 
1

 
49

 
2

 
283

Consumer unsecured

 

 
1

 
2

 

 

 

 

Total
2

 
$
26

 
1

 
$
2

 
3

 
$
232

 
4

 
$
614

We did not restructure any loans by forgiving principal or accrued interest in the three month periods ended March 31, 2016 or 2015.
Based on our historical loss experience, losses associated with TDRs are not significantly different than other impaired loans within the same loan segment. As such, TDRs, including TDRs that have been modified in the past 12 months that subsequently defaulted, are analyzed in the same manner as other impaired loans within their respective loan segment.
We had no loans that defaulted in the three month periods ended March 31, 2016 and 2015 which were modified within 12 months prior to the default date.
The following is a summary of TDR loan balances as of:
 
March 31
2016
 
December 31
2015
TDRs
$
19,988

 
$
21,325


23

Table of Contents

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

March 31
2016
 
December 31
2015
FHLB Stock
$
11,700

 
$
11,700

Corporate Settlement Solutions, LLC
7,192

 
7,249

FRB Stock
1,999

 
1,999

Valley Financial Corporation
1,000

 
1,000

Other
335

 
338

Total
$
22,226

 
$
22,286

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

March 31
2016
 
December 31
2015
Consumer mortgage loans collateralized by residential real estate foreclosed as a result of obtaining physical possession
$
35

 
$

All other foreclosed assets
241

 
421

Total
$
276

 
$
421

Changes in foreclosed assets are summarized as follows during the three months ended March 31:

2016
 
2015
Balance, January 1
$
421

 
$
885

Properties transferred
89

 
134

Proceeds from sale
(234
)
 
(302
)
Balance, March 31
$
276

 
$
717

There were no consumer mortgage loans collateralized by residential real estate in the process of foreclosure as of March 31, 2016.
Note 8 – Borrowed Funds
Borrowed funds consist of the following obligations as of:
 
March 31, 2016
 
December 31, 2015

Amount
 
Rate
 
Amount
 
Rate
FHLB advances
$
245,000

 
1.94
%
 
$
235,000

 
1.93
%
Securities sold under agreements to repurchase without stated maturity dates
58,096

 
0.13
%
 
70,532

 
0.12
%
Federal funds purchased
4,800

 
0.64
%
 
4,200

 
0.75
%
Total
$
307,896

 
1.58
%
 
$
309,732

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

24

Table of Contents

The following table lists the maturities and weighted average interest rates of FHLB advances as of:
 
March 31, 2016
 
December 31, 2015

Amount
 
Rate
 
Amount
 
Rate
Fixed rate due 2016
$
20,000

 
1.62
%
 
$
30,000

 
1.25
%
Variable rate due 2016
15,000

 
0.76
%
 
15,000

 
0.62
%
Fixed rate due 2017
50,000

 
1.56
%
 
50,000

 
1.56
%
Fixed rate due 2018
50,000

 
2.16
%
 
50,000

 
2.16
%
Fixed rate due 2019
60,000

 
1.99
%
 
40,000

 
2.35
%
Fixed rate due 2020
10,000

 
1.98
%
 
10,000

 
1.98
%
Fixed rate due 2021
30,000

 
2.26
%
 
30,000

 
2.26
%
Fixed rate due 2023
10,000

 
3.90
%
 
10,000

 
3.90
%
Total
$
245,000

 
1.94
%
 
$
235,000

 
1.93
%
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 $58,137 and $70,555 at March 31, 2016 and December 31, 2015, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.
Securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances generally mature within one to four days from the transaction date. The following table provides a summary of securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances borrowings for the three month periods ended:
 
March 31, 2016
 
March 31, 2015

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
$
61,783

 
$
61,051

 
0.12
%
 
$
84,859

 
$
79,052

 
0.13
%
Federal funds purchased
4,800

 
4,696

 
0.69
%
 
2,300

 
5,706

 
0.48
%
We had pledged AFS securities and 1-4 family residential real estate loans in the following amounts at:

March 31
2016
 
December 31
2015
Pledged to secure borrowed funds
$
335,570

 
$
339,078

Pledged to secure repurchase agreements
58,137

 
70,555

Pledged for public deposits and for other purposes necessary or required by law
38,465

 
39,038

Total
$
432,172

 
$
448,671

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

March 31
2016
 
December 31
2015
States and political subdivisions
$
2,393

 
$
3,639

Mortgage-backed securities
20,781

 
23,075

Collateralized mortgage obligations
34,963

 
43,841

Total
$
58,137

 
$
70,555

AFS securities pledged to repurchase agreements are monitored to ensure the appropriate level is collateralized. In the event of maturities, calls, significant principal repayments, or significant decline in market values, we have adequate levels of available AFS securities to pledge to satisfy required collateral.
As of March 31, 2016, we had the ability to borrow up to an additional $107,598, based on assets pledged as collateral. We had no investment securities that are restricted to be pledged for specific purposes.

25

Table of Contents

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

Three Months Ended 
 March 31
 
2016
 
2015
Director fees
$
209

 
$
198

FDIC insurance premiums
205

 
212

Audit and related fees
159

 
184

Marketing costs
155

 
112

Education and travel
123

 
92

Donations and community relations
111

 
143

Loan underwriting fees
108

 
88

Consulting fees
173

 
84

Postage and freight
106

 
98

Printing and supplies
78

 
102

All other
639

 
561

Total other
$
2,066

 
$
1,874

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

Three Months Ended 
 March 31
 
2016
 
2015
Income taxes at 34% statutory rate
$
1,174

 
$
1,511

Effect of nontaxable income
 
 
 
Interest income on tax exempt municipal securities
(502
)
 
(500
)
Earnings on corporate owned life insurance policies
(64
)
 
(64
)
Effect of tax credits
(194
)
 
(186
)
Other
(18
)
 
(26
)
Total effect of nontaxable income
(778
)
 
(776
)
Effect of nondeductible expenses
41

 
36

Federal income tax expense
$
437

 
$
771


26

Table of Contents

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

March 31, 2016
Valuation Technique
Fair Value
Unobservable Input
 
Range
 
 
Discount applied to collateral appraisal:
 
 
 
 
Real Estate
 
20% - 30%
 
 
Equipment
 
35%
Discounted appraisal value
$7,825
Furniture, fixtures & equipment
 
35% - 45%
 
 
Cash crop inventory
 
40%
 
 
Other inventory
 
50%
 
 
Accounts receivable
 
50%
 
 
Liquor license
 
75%

27

Table of Contents


December 31, 2015
Valuation Technique
Fair Value
Unobservable Input
 
Range
 
 
Discount applied to collateral appraisal:
 
 
 
 
Real Estate
 
20% - 30%
 
 
Equipment
 
20% - 35%
Discounted appraisal value
$9,301
Furniture, fixtures & equipment
 
35% - 45%
 
 
Cash crop inventory
 
40%
 
 
Other inventory
 
50%
 
 
Accounts receivable
 
50%
 
 
Liquor license
 
75%
Discount factors with ranges are based on the age of the independent appraisal, broker price opinion, or internal evaluation.
Accrued interest receivable: The carrying amounts of accrued interest receivable approximate fair value. As such, we classify accrued interest receivable as Level 1.
Equity securities without readily determinable fair values: Included in equity securities without readily determinable fair values are FHLB stock and FRB stock as well as our 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 and 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 and we account for our investment under the cost method of accounting.
The lack of an active market, or other independent sources to validate fair value estimates coupled with the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. As the fair values of these investments are not readily determinable, they are not disclosed under a specific fair value hierarchy; however, they are reviewed quarterly for impairment. If we were to record an impairment adjustment related to these securities, it would be classified as a nonrecurring Level 3 fair value adjustment. During 2016 and 2015, there were no impairments recorded on equity securities without readily determinable fair values.
Foreclosed assets: Upon transfer from the loan portfolio, foreclosed assets (which are included in other assets) are adjusted to and subsequently carried at the lower of carrying value or fair value less costs to sell. Net realizable value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. Due to the inherent level of estimation in the valuation process, we classify foreclosed assets as nonrecurring Level 3.
The table below lists the quantitative fair value information related to foreclosed assets as of:
 
March 31, 2016
Valuation Technique
Fair Value
 
Unobservable Input
 
Range
 
 
 
Discount applied to collateral appraisal:
 
 
Discounted appraisal value
$
276

 
Real Estate
 
20% - 30%
 
December 31, 2015
Valuation Technique
Fair Value
 
Unobservable Input
 
Range
 
 
 
Discount applied to collateral appraisal:
 
 
Discounted appraisal value
$
421

 
Real Estate
 
20% - 30%
Discount factors with ranges are based on the age of the independent appraisal, broker price opinion, or internal evaluations.

28

Table of Contents

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 2016 and 2015, there were no impairments recorded on goodwill and other acquisition intangibles.
OMSR: OMSR (which are included in other assets) are subject to impairment testing. To test for impairment, we utilize a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and discount rates. If the valuation model reflects a value less than the carrying value, OMSR are adjusted to fair value through a valuation allowance as determined by the model. As such, we classify OMSR subject to nonrecurring fair value adjustments as Level 2.
Deposits: The fair value of demand, savings, and money market deposits are equal to their carrying amounts and are classified as Level 1. Fair values for variable rate certificates of deposit approximate their carrying value. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. As such, fixed rate certificates of deposit are classified as Level 2.
Borrowed funds: The carrying amounts of federal funds purchased, borrowings under overnight repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values. The fair values of other borrowed funds are estimated using discounted cash flow analyses based on current incremental borrowing arrangements. As such, borrowed funds are classified as Level 2.
Accrued interest payable: The carrying amounts of accrued interest payable approximate fair value. As such, we classify accrued interest payable as Level 1.
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.

29

Table of Contents

Estimated Fair Values of Financial Instruments Not Recorded at Fair Value in their Entirety on a Recurring Basis
Disclosure of the estimated fair values of financial instruments, which differ from carrying values, often requires the use of estimates. In cases where quoted market values in an active market are not available, we use present value techniques and other valuation methods to estimate the fair values of our financial instruments. These valuation methods require considerable judgment and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used.
The carrying amount and estimated fair value of financial instruments not recorded at fair value in their entirety on a recurring basis were as follows as of:
 
March 31, 2016

Carrying
Value
 
Estimated
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
28,127

 
$
28,127

 
$
28,127

 
$

 
$

Mortgage loans AFS
1,240

 
1,250

 

 
1,250

 

Gross loans
870,291

 
861,103

 

 

 
861,103

Less allowance for loan and lease losses
7,500

 
7,500

 

 

 
7,500

Net loans
862,791

 
853,603

 

 

 
853,603

Accrued interest receivable
6,995

 
6,995

 
6,995

 

 

Equity securities without readily determinable fair values (1)
22,226

 
N/A

 

 

 

OMSR
2,403

 
2,403

 

 
2,403

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
751,262

 
751,262

 
751,262

 

 

Deposits with stated maturities
422,245

 
422,049

 

 
422,049

 

Borrowed funds
307,896

 
311,927

 

 
311,927

 

Accrued interest payable
585

 
585

 
585

 

 

 
December 31, 2015
 
Carrying
Value
 
Estimated
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
21,569

 
$
21,569

 
$
21,569

 
$

 
$

Mortgage loans AFS
1,187

 
1,210

 

 
1,210

 

Gross loans
850,492

 
839,398

 

 

 
839,398

Less allowance for loan and lease losses
7,400

 
7,400

 

 

 
7,400

Net loans
843,092

 
831,998

 

 

 
831,998

Accrued interest receivable
6,269

 
6,269

 
6,269

 

 

Equity securities without readily determinable fair values (1)
22,286

 
N/A

 

 

 

OMSR
2,505

 
2,518

 

 
2,518

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
741,683

 
741,683

 
741,683

 

 

Deposits with stated maturities
422,880

 
421,429

 

 
421,429

 

Borrowed funds
309,732

 
312,495

 

 
312,495

 

Accrued interest payable
545

 
545

 
545

 

 

(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.

30

Table of Contents

Financial Instruments Recorded at Fair Value
The table below presents the recorded amount of assets and liabilities measured at fair value on:
 
March 31, 2016
 
December 31, 2015

Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Recurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AFS securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprises
$
24,428

 
$

 
$
24,428

 
$

 
$
24,345

 
$

 
$
24,345

 
$

States and political subdivisions
231,472

 

 
231,472

 

 
232,217

 

 
232,217

 

Auction rate money market preferred
2,807

 

 
2,807

 

 
2,866

 

 
2,866

 

Preferred stocks
3,346

 
3,346

 

 

 
3,299

 
3,299

 

 

Mortgage-backed securities
258,284

 

 
258,284

 

 
263,384

 

 
263,384

 

Collateralized mortgage obligations
129,522

 

 
129,522

 

 
134,025

 

 
134,025

 

Total AFS securities
649,859

 
3,346

 
646,513

 

 
660,136

 
3,299

 
656,837

 

Nonrecurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans (net of the ALLL)
7,825

 

 

 
7,825

 
9,301

 

 

 
9,301

Foreclosed assets
276

 

 

 
276

 
421

 

 

 
421

Total
$
657,960

 
$
3,346

 
$
646,513

 
$
8,101

 
$
669,858

 
$
3,299

 
$
656,837

 
$
9,722

Percent of assets and liabilities measured at fair value
 
 
0.51
%
 
98.26
%
 
1.23
%
 
 
 
0.49
%
 
98.06
%
 
1.45
%
We had no assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a recurring basis, as of March 31, 2016. Additionally, we had no assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a nonrecurring basis, as of March 31, 2016.

31

Table of Contents

Note 12 – Accumulated Other Comprehensive Income
The following table summarizes the changes in AOCI by component for the:
 
Three Months Ended March 31
 
2016
 
2015

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
$
3,536

 
$
(3,315
)
 
$
221

 
$
3,302

 
$
(3,808
)
 
$
(506
)
OCI before reclassifications
7,274

 

 
7,274

 
4,356

 

 
4,356

Amounts reclassified from AOCI

 

 

 

 

 

Subtotal
7,274

 

 
7,274

 
4,356

 

 
4,356

Tax effect
(2,477
)
 

 
(2,477
)
 
(1,366
)
 

 
(1,366
)
OCI, net of tax
4,797

 

 
4,797

 
2,990

 

 
2,990

Balance, March 31
$
8,333

 
$
(3,315
)
 
$
5,018

 
$
6,292

 
$
(3,808
)
 
$
2,484

Included in OCI for the three month periods ended March 31, 2016 and 2015 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 March 31
 
2016
 
2015

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
$
(12
)
 
$
7,286

 
$
7,274

 
$
340

 
$
4,016

 
$
4,356

Tax effect

 
(2,477
)
 
(2,477
)
 

 
(1,366
)
 
(1,366
)
Unrealized gains (losses), net of tax
$
(12
)
 
$
4,809

 
$
4,797

 
$
340

 
$
2,650

 
$
2,990


32

Table of Contents

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

March 31
2016
 
December 31
2015
ASSETS
 
 
 
Cash on deposit at the Bank
$
3,690

 
$
4,125

AFS securities
255

 
257

Investments in subsidiaries
140,596

 
133,883

Premises and equipment
2,018

 
2,014

Other assets
53,163

 
53,396

TOTAL ASSETS
$
199,722

 
$
193,675

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Other liabilities
$
9,475

 
$
9,704

Shareholders' equity
190,247

 
183,971

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
199,722

 
$
193,675

Interim Condensed Statements of Income
 
Three Months Ended 
 March 31

2016
 
2015
Income
 
 
 
Dividends from subsidiaries
$
1,600

 
$
1,600

Interest income
4

 
36

Management fee and other
1,524

 
1,452

Total income
3,128

 
3,088

Expenses
 
 
 
Compensation and benefits
1,200

 
1,190

Occupancy and equipment
430

 
410

Audit and related fees
96

 
101

Other
546

 
493

Total expenses
2,272

 
2,194

Income before income tax benefit and equity in undistributed earnings of subsidiaries
856

 
894

Federal income tax benefit
246

 
241

Income before equity in undistributed earnings of subsidiaries
1,102

 
1,135

Undistributed earnings of subsidiaries
1,915

 
2,538

Net income
$
3,017

 
$
3,673



33

Table of Contents

Interim Condensed Statements of Cash Flows
 
Three Months Ended 
 March 31

2016
 
2015
Operating activities
 
 
 
Net income
$
3,017

 
$
3,673

Adjustments to reconcile net income to cash provided by operations
 
 
 
Undistributed earnings of subsidiaries
(1,915
)
 
(2,538
)
Undistributed earnings of equity securities without readily determinable fair values
61

 
27

Share-based payment awards under equity compensation plan
158

 
146

Depreciation
41

 
36

Changes in operating assets and liabilities which provided (used) cash
 
 
 
Other assets
173

 
223

Accrued interest and other liabilities
(229
)
 
(377
)
Net cash provided by (used in) operating activities
1,306

 
1,190

Investing activities
 
 
 
Purchases of premises and equipment
(45
)
 
(59
)
Net cash provided by (used in) investing activities
(45
)
 
(59
)
Financing activities
 
 
 
Cash dividends paid on common stock
(1,872
)
 
(1,775
)
Proceeds from the issuance of common stock
1,072

 
945

Common stock repurchased
(799
)
 
(820
)
Common stock purchased for deferred compensation obligations
(97
)
 
(100
)
Net cash provided by (used in) financing activities
(1,696
)
 
(1,750
)
Increase (decrease) in cash and cash equivalents
(435
)
 
(619
)
Cash and cash equivalents at beginning of period
4,125

 
1,035

Cash and cash equivalents at end of period
$
3,690

 
$
416

Note 14 – Operating Segments
Our reportable segments are based on legal entities that account for at least 10% of net operating results. The operations of the Bank as of March 31, 2016 and 2015 and each of the three month periods then ended, represent approximately 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented.

34

Table of Contents

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
ISABELLA BANK CORPORATION FINANCIAL REVIEW
(Dollars in thousands except per share amounts)
This section reviews our financial condition and results of our operations for the unaudited three month periods ended March 31, 2016 and 2015. This analysis should be read in conjunction with our 2015 Annual Report on Form 10-K and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 4 of this report.
Executive Summary
During the three months ended March 31, 2016 and 2015, we reported net income of $3,017 and $3,673 and earnings per common share of $0.39 and $0.47, respectively. While interest income for 2016 increased $328 in comparison to the same period in 2015, our net earnings declined as a result of growth in our commercial loan portfolio which contributed to an increase in the provision for loan losses. For the three month period ended March 31, 2016, the provision for loan losses was $156. Net loans charged-off during the first three months of 2016 were $56 as compared to net loan recoveries of $226 in the first three months of 2015. During the first quarter of 2015, we began to see a significant improvement in loan credit quality indicators through low levels of loans classified as less than satisfactory in addition to those considered to be nonperforming. This improvement along with net recoveries and a reduction in gross loans, resulted in a reversal of provision for loan losses of $726 for the three month period ended March 31, 2015.
During the three month period ended March 31, 2016, total assets grew by 0.82% to $1,681,818, and assets under management increased to $2,372,660 which includes loans sold and serviced, and assets managed by our Investment and Trust Services Department of $690,842. Total loans increased by $19,799 from December 31, 2015 which was largely driven by growth in the commercial portfolio. Growth in our residential mortgage and consumer loan portfolios has been challenging; however, we are implementing new products, enhancing our marketing efforts and streamlining delivery channels for direct and indirect loans. These initiatives are designed to generate growth by attracting new customers while expanding our relationships with current customers.
Our net yield on interest earning assets remains historically low at 2.98% for the three month period ended March 31, 2016. The growth in net interest income will increase only through continued growth in loans, investments, and other income earning assets. We do not anticipate that the Federal Reserve Bank will increase short term interest rates significantly in 2016; therefore, we do not anticipate any significant improvements in our net yield on interest earning assets in the short term. We are committed to increasing earnings and dedicated to providing long term sustainable growth to enable us to increase shareholder value.
Reclassifications: Certain amounts reported in the 2015 consolidated financial statements have been reclassified to conform with the 2016 presentation.
Restatements: In this Quarterly Report on Form 10-Q, certain prior period financial information has been restated due to an accounting correction. All amounts in this Quarterly Report on Form 10-Q affected by the restatement adjustments reflect such amounts as restated. For information related the restatement, refer to our Annual Report on Form 10-K for the year ended December 31, 2015.

35

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:

March 31
2016
 
December 31
2015
 
September 30
2015
 
June 30
2015
 
March 31
2015
INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
Interest income
$
13,081

 
$
13,023

 
$
12,967

 
$
12,759

 
$
12,753

Interest expense
2,614

 
2,577

 
2,580

 
2,518

 
2,488

Net interest income
10,467

 
10,446

 
10,387

 
10,241

 
10,265

Provision for loan losses
156

 
(772
)
 
(738
)
 
(535
)
 
(726
)
Noninterest income
2,223

 
2,501

 
3,101

 
2,629

 
2,128

Noninterest expenses
9,080

 
9,885

 
9,161

 
8,330

 
8,675

Federal income tax expense
437

 
538

 
1,002

 
977

 
771

Net Income
$
3,017

 
$
3,296

 
$
4,063

 
$
4,098

 
$
3,673

PER SHARE
 
 
 
 
 
 
 
 
 
Basic earnings
$
0.39

 
$
0.42

 
$
0.52

 
$
0.53

 
$
0.47

Diluted earnings
$
0.38

 
$
0.41

 
$
0.51

 
$
0.52

 
$
0.46

Dividends
$
0.24

 
$
0.24

 
$
0.24

 
$
0.23

 
$
0.23

Tangible book value*
$
17.47

 
$
17.30

 
$
17.06

 
$
17.17

 
$
16.84

Quoted market value
 
 
 
 
 
 
 
 
 
High
$
29.90

 
$
29.90

 
$
23.85

 
$
23.80

 
$
23.50

Low
$
27.25

 
$
23.50

 
$
22.75

 
$
22.70

 
$
22.00

Close*
$
28.25

 
$
29.90

 
$
23.69

 
$
23.75

 
$
22.90

Common shares outstanding*
7,809,079

 
7,799,867

 
7,765,333

 
7,797,188

 
7,781,820

PERFORMANCE RATIOS
 
 
 
 
 
 
 
 
 
Return on average total assets
0.72
%
 
0.81
%
 
1.01
%
 
1.04
%
 
0.95
%
Return on average shareholders' equity
6.37
%
 
7.17
%
 
9.03
%
 
9.11
%
 
8.27
%
Return on average tangible shareholders' equity
8.88
%
 
9.83
%
 
12.18
%
 
12.35
%
 
11.30
%
Net interest margin yield (FTE)
2.98
%
 
3.04
%
 
3.09
%
 
3.11
%
 
3.18
%
BALANCE SHEET DATA*
 
 
 
 
 
 
 
 
 
Gross loans
$
870,291

 
$
850,492

 
$
836,671

 
$
831,831

 
$
818,493

AFS securities
$
649,859

 
$
660,136

 
$
628,612

 
$
595,318

 
$
605,208

Total assets
$
1,681,818

 
$
1,668,112

 
$
1,619,250

 
$
1,586,975

 
$
1,571,575

Deposits
$
1,173,507

 
$
1,164,563

 
$
1,128,003

 
$
1,090,469

 
$
1,098,655

Borrowed funds
$
307,896

 
$
309,732

 
$
297,610

 
$
307,599

 
$
283,321

Shareholders' equity
$
190,247

 
$
183,971

 
$
182,998

 
$
178,025

 
$
179,653

Gross loans to deposits
74.16
%
 
73.03
%
 
74.17
%
 
76.28
%
 
74.50
%
ASSETS UNDER MANAGEMENT*
 
 
 
 
 
 
 
 
 
Loans sold with servicing retained
$
282,618

 
$
287,029

 
$
289,268

 
$
289,089

 
$
288,448

Assets managed by our Investment and Trust Services Department
$
408,224

 
$
405,109

 
$
392,124

 
$
400,827

 
$
396,802

Total assets under management
$
2,372,660

 
$
2,360,250

 
$
2,300,642

 
$
2,276,891

 
$
2,256,825

ASSET QUALITY*
 
 
 
 
 
 
 
 
 
Nonperforming loans to gross loans
0.12
%
 
0.09
%
 
0.10
%
 
0.19
%
 
0.44
%
Nonperforming assets to total assets
0.08
%
 
0.07
%
 
0.09
%
 
0.15
%
 
0.27
%
ALLL to gross loans
0.86
%
 
0.87
%
 
0.98
%
 
1.09
%
 
1.17
%
CAPITAL RATIOS*
 
 
 
 
 
 
 
 
 
Shareholders' equity to assets
11.31
%
 
11.03
%
 
11.30
%
 
11.22
%
 
11.43
%
Tier 1 leverage
8.44
%
 
8.52
%
 
8.54
%
 
8.77
%
 
8.74
%
Common equity tier 1 capital
13.24
%
 
13.44
%
 
13.57
%
 
13.93
%
 
13.71
%
Tier 1 risk-based capital
13.24
%
 
13.44
%
 
13.57
%
 
13.93
%
 
13.71
%
Total risk-based capital
13.97
%
 
14.17
%
 
14.41
%
 
14.86
%
 
14.71
%
* At end of period

36

Table of Contents

The following table outlines our results of operations and provides certain performance measures as of, and for the three month periods ended:
 
March 31
2016
 
March 31
2015
 
March 31
2014
 
March 31
2013
 
March 31
2012
INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
Interest income
$
13,081

 
$
12,753

 
$
12,693

 
$
12,602

 
$
13,532

Interest expense
2,614

 
2,488

 
2,500

 
2,821

 
3,704

Net interest income
10,467

 
10,265

 
10,193

 
9,781

 
9,828

Provision for loan losses
156

 
(726
)
 
(242
)
 
300

 
461

Noninterest income
2,223

 
2,128

 
2,249

 
2,447

 
3,541

Noninterest expenses
9,080

 
8,675

 
8,815

 
8,265

 
8,901

Federal income tax expense
437

 
771

 
560

 
576

 
773

Net Income
$
3,017

 
$
3,673


$
3,309

 
$
3,087

 
$
3,234

PER SHARE
 
 
 
 
 
 
 
 
 
Basic earnings
$
0.39

 
$
0.47

 
$
0.43

 
$
0.40

 
$
0.43

Diluted earnings
$
0.38

 
$
0.46

 
$
0.42

 
$
0.39

 
$
0.41

Dividends
$
0.24

 
$
0.23

 
$
0.22

 
$
0.21

 
$
0.20

Tangible book value*
$
17.47

 
$
16.84

 
$
15.82

 
$
14.95

 
$
14.15

Quoted market value
 
 
 
 
 
 
 
 
 
High
$
29.90

 
$
23.50

 
$
23.94

 
$
25.10

 
$
24.50

Low
$
27.25

 
$
22.00

 
$
22.25

 
$
21.55

 
$
22.30

Close*
$
28.25

 
$
22.90

 
$
23.00

 
$
25.00

 
$
24.00

Common shares outstanding*
7,809,079

 
7,781,820

 
7,727,547

 
7,688,928

 
7,596,772

PERFORMANCE RATIOS
 
 
 
 
 
 
 
 
 
Return on average total assets
0.72
%
 
0.95
%
 
0.88
%
 
0.86
%
 
0.95
%
Return on average shareholders' equity
6.37
%
 
8.27
%
 
8.04
%
 
7.51
%
 
8.29
%
Return on average tangible shareholders' equity
8.88
%
 
11.30
%
 
10.92
%
 
10.86
%
 
12.19
%
Net interest margin yield (FTE)
2.98
%
 
3.18
%
 
3.21
%
 
3.25
%
 
3.47
%
BALANCE SHEET DATA*
 
 
 
 
 
 
 
 
 
Gross loans
$
870,291

 
$
818,493

 
$
811,242

 
$
769,574

 
$
744,427

AFS securities
$
649,859

 
$
605,208

 
$
555,144

 
$
520,931

 
$
471,655

Total assets
$
1,681,818

 
$
1,571,575

 
$
1,513,371

 
$
1,434,705

 
$
1,369,220

Deposits
$
1,173,507

 
$
1,098,655

 
$
1,065,935

 
$
1,029,760

 
$
989,126

Borrowed funds
$
307,896

 
$
283,321

 
$
272,536

 
$
232,410

 
$
214,493

Shareholders' equity
$
190,247

 
$
179,653

 
$
165,971

 
$
165,308

 
$
157,307

Gross loans to deposits
74.16
%
 
74.50
%
 
76.11
%
 
74.73
%
 
75.26
%
ASSETS UNDER MANAGEMENT*
 
 
 
 
 
 
 
 
 
Loans sold with servicing retained
$
282,618

 
$
288,448

 
$
292,382

 
$
301,476

 
$
304,235

Assets managed by our Investment and Trust Services Department
$
408,224

 
$
396,802

 
$
358,811

 
$
336,632

 
$
312,304

Total assets under management
$
2,372,660

 
$
2,256,825

 
$
2,164,564

 
$
2,072,813

 
$
1,985,759

ASSET QUALITY*
 
 
 
 
 
 
 
 
 
Nonperforming loans to gross loans
0.12
%
 
0.44
%
 
0.65
%
 
0.90
%
 
0.94
%
Nonperforming assets to total assets
0.08
%
 
0.27
%
 
0.42
%
 
0.56
%
 
0.64
%
ALLL to gross loans
0.86
%
 
1.17
%
 
1.37
%
 
1.55
%
 
1.66
%
CAPITAL RATIOS*
 
 
 
 
 
 
 
 
 
Shareholders' equity to assets
11.31
%
 
11.43
%
 
10.97
%
 
11.52
%
 
11.49
%
Tier 1 leverage
8.44
%
 
8.74
%
 
8.38
%
 
8.28
%
 
8.19
%
Common equity tier 1 capital
13.24
%
 
13.71
%
 
N/A

 
N/A

 
N/A

Tier 1 risk-based capital
13.24
%
 
13.71
%
 
13.89
%
 
13.62
%
 
13.20
%
Total risk-based capital
13.97
%
 
14.71
%
 
15.14
%
 
14.87
%
 
14.45
%
* At end of period

37

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. Loans in nonaccrual status, for the purpose of the following computations, are included in the average loan balances. FRB and FHLB restricted equity holdings are included in accrued income and other assets.
 
March 31, 2016
 
December 31, 2015
 
March 31, 2015
 
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
$
857,784

 
$
9,038

 
4.21
%
 
$
840,849

 
$
8,969

 
4.27
%
 
$
825,025

 
$
9,025

 
4.38
%
Taxable investment securities
432,747

 
2,400

 
2.22
%
 
416,451

 
2,398

 
2.30
%
 
370,586

 
2,107

 
2.27
%
Nontaxable investment securities
211,695

 
2,424

 
4.58
%
 
213,885

 
2,447

 
4.58
%
 
197,597

 
2,471

 
5.00
%
Other
26,929

 
158

 
2.35
%
 
26,430

 
156

 
2.36
%
 
24,421

 
139

 
2.28
%
Total earning assets
1,529,155

 
14,020

 
3.67
%
 
1,497,615

 
13,970

 
3.73
%
 
1,417,629

 
13,742

 
3.88
%
NONEARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses
(7,439
)
 
 
 
 
 
(8,252
)
 
 
 
 
 
(10,308
)
 
 
 
 
Cash and demand deposits due from banks
17,769

 
 
 
 
 
18,254

 
 
 
 
 
17,624

 
 
 
 
Premises and equipment
28,253

 
 
 
 
 
28,408

 
 
 
 
 
26,307

 
 
 
 
Accrued income and other assets
100,770

 
 
 
 
 
100,563

 
 
 
 
 
97,795

 
 
 
 
Total assets
$
1,668,508

 
 
 
 
 
$
1,636,588

 
 
 
 
 
$
1,549,047

 
 
 
 
INTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
$
208,309

 
42

 
0.08
%
 
$
197,043

 
39

 
0.08
%
 
$
194,636

 
39

 
0.08
%
Savings deposits
342,540

 
144

 
0.17
%
 
319,903

 
138

 
0.17
%
 
270,792

 
92

 
0.14
%
Time deposits
420,913

 
1,213

 
1.15
%
 
426,229

 
1,268

 
1.19
%
 
437,210

 
1,335

 
1.22
%
Borrowed funds
310,637

 
1,215

 
1.56
%
 
305,970

 
1,132

 
1.48
%
 
283,535

 
1,022

 
1.44
%
Total interest bearing liabilities
1,282,399

 
2,614

 
0.82
%
 
1,249,145

 
2,577

 
0.83
%
 
1,186,173

 
2,488

 
0.84
%
NONINTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
187,067

 
 
 
 
 
191,974

 
 
 
 
 
174,037

 
 
 
 
Other
9,592

 
 
 
 
 
11,466

 
 
 
 
 
11,087

 
 
 
 
Shareholders’ equity
189,450

 
 
 
 
 
184,003

 
 
 
 
 
177,750

 
 
 
 
Total liabilities and shareholders’ equity
$
1,668,508

 
 
 
 
 
$
1,636,588

 
 
 
 
 
$
1,549,047

 
 
 
 
Net interest income (FTE)
 
 
$
11,406

 
 
 
 
 
$
11,393

 
 
 
 
 
$
11,254

 
 
Net yield on interest earning assets (FTE)
 
 
 
 
2.98
%
 
 
 
 
 
3.04
%
 
 
 
 
 
3.18
%
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, and nontaxable investment securities, thus making year to year comparisons more meaningful.

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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 
 March 31, 2016 Compared to  
 December 31, 2015 
  Increase (Decrease) Due to
 
Three Months Ended 
 March 31, 2016 Compared to  
 March 31, 2015 
  Increase (Decrease) Due to

Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Changes in interest income
 
 
 
 
 
 
 
 
 
 
 
Loans
$
179

 
$
(110
)
 
$
69

 
$
352

 
$
(339
)
 
$
13

Taxable investment securities
92

 
(90
)
 
2

 
346

 
(53
)
 
293

Nontaxable investment securities
(25
)
 
2

 
(23
)
 
169

 
(216
)
 
(47
)
Other
3

 
(1
)
 
2

 
15

 
4

 
19

Total changes in interest income
249

 
(199
)
 
50

 
882

 
(604
)
 
278

Changes in interest expense
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
2

 
1

 
3

 
3

 

 
3

Savings deposits
10

 
(4
)
 
6

 
27

 
25

 
52

Time deposits
(16
)
 
(39
)
 
(55
)
 
(49
)
 
(73
)
 
(122
)
Borrowed funds
17

 
66

 
83

 
102

 
91

 
193

Total changes in interest expense
13

 
24

 
37

 
83

 
43

 
126

Net change in interest margin (FTE)
$
236

 
$
(223
)
 
$
13

 
$
799

 
$
(647
)
 
$
152

Our net yield on interest earning assets remains at historically low levels. The persistent low interest rate environment coupled with an increase in the concentration of AFS securities as a percentage of earning assets has also placed downward pressure on net interest margin yield. During the remainder of 2016, we do not expect any significant change in our net yield on interest earning assets as the rates paid on interest bearing liabilities will likely increase as fast as those of interest earning assets. Net interest income will increase only through continued balance sheet growth.
 
Average Yield / Rate for the Three Month Periods Ended:

March 31
2016

December 31
2015

September 30
2015

June 30
2015

March 31
2015
Total earning assets
3.67
%
 
3.73
%
 
3.79
%
 
3.81
%
 
3.88
%
Total interest bearing liabilities
0.82
%
 
0.83
%
 
0.84
%
 
0.84
%
 
0.84
%
Net yield on interest earning assets (FTE)
2.98
%

3.04
%
 
3.09
%
 
3.11
%
 
3.18
%
 
Quarter to Date Net Interest Income (FTE)

March 31
2016
 
December 31
2015
 
September 30
2015
 
June 30
2015
 
March 31
2015
Total interest income (FTE)
$
14,020

 
$
13,970

 
$
13,919

 
$
13,748

 
$
13,742

Total interest expense
2,614

 
2,577

 
2,580

 
2,518

 
2,488

Net interest income (FTE)
$
11,406

 
$
11,393

 
$
11,339

 
$
11,230

 
$
11,254


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Table of Contents

Allowance for Loan and Lease Losses
The viability of any financial institution is ultimately determined by its management of credit risk. Loans represent our single largest concentration of risk. The ALLL is our estimation of incurred losses within the existing loan portfolio. We allocate the ALLL throughout the loan portfolio based on our assessment of the underlying risks associated with each loan segment. Our assessments include allocations based on specific impairment valuation allowances, historical charge-offs, internally assigned credit risk ratings, and past due and nonaccrual balances. A portion of the ALLL is not allocated to any one loan segment, but is instead a 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-offs, recoveries, provisions for loan losses, and ALLL balances as of, and for the three month periods ended March 31:

2016
 
2015
 
Variance
ALLL at beginning of period
$
7,400

 
$
10,100

 
$
(2,700
)
Charge-offs
 
 
 
 
 
Commercial and agricultural
16

 
17

 
(1
)
Residential real estate
241

 
50

 
191

Consumer
84

 
93

 
(9
)
Total charge-offs
341

 
160

 
181

Recoveries
 
 
 
 
 
Commercial and agricultural
181

 
285

 
(104
)
Residential real estate
50

 
33

 
17

Consumer
54

 
68

 
(14
)
Total recoveries
285

 
386

 
(101
)
Net loan charge-offs
56

 
(226
)
 
282

Provision for loan losses
156

 
(726
)
 
882

ALLL at end of period
$
7,500

 
$
9,600

 
$
(2,100
)
Net loan charge-offs to average loans outstanding
0.01
%
 
(0.03
)%
 
0.04
%
The following table summarizes our charge-offs, recoveries, provisions for loan losses, and ALLL balances as of, and for the three month periods ended:

March 31
2016
 
December 31
2015
 
September 30
2015
 
June 30
2015
 
March 31
2015
Total charge-offs
$
341

 
$
238

 
$
210

 
$
296

 
$
160

Total recoveries
285

 
210

 
148

 
231

 
386

Net loan charge-offs
56

 
28

 
62

 
65

 
(226
)
Net loan charge-offs to average loans outstanding
0.01
%
 
 %
 
0.01
 %
 
0.01
 %
 
(0.03
)%
Provision for loan losses
$
156

 
$
(772
)
 
$
(738
)
 
$
(535
)
 
$
(726
)
Provision for loan losses to average loans outstanding
0.02
%
 
(0.09
)%
 
(0.09
)%
 
(0.07
)%
 
(0.09
)%
ALLL
$
7,500

 
$
7,400

 
$
8,200

 
$
9,000

 
$
9,600

ALLL as a % of loans at end of period
0.86
%
 
0.87
 %
 
0.98
 %
 
1.08
 %
 
1.17
 %
During 2015, net loan recoveries and continued improvement in credit quality indicators resulted in a reduction of the ALLL in both amount and as a percentage of loans. Loan growth during 2016 and an increase in net loans charged-off led to an increase in the level of ALLL as of March 31, 2016.

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Table of Contents

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

March 31
2016
 
December 31
2015
 
September 30
2015
 
June 30
2015
 
March 31
2015
ALLL
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,731

 
$
2,820

 
$
3,217

 
$
3,202

 
$
3,361

Collectively evaluated for impairment
4,769

 
4,580

 
4,983

 
5,798

 
6,239

Total
$
7,500

 
$
7,400

 
$
8,200

 
$
9,000

 
$
9,600

ALLL to gross loans
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
0.31
%
 
0.33
%
 
0.38
%
 
0.38
%
 
0.41
%
Collectively evaluated for impairment
0.55
%
 
0.54
%
 
0.60
%
 
0.70
%
 
0.76
%
Total
0.86
%
 
0.87
%
 
0.98
%
 
1.08
%
 
1.17
%
While more volatile, loans individually evaluated for impairment have been relatively flat in recent quarters. The decline in loans collectively impaired during 2015 illustrates the downward trend we are experiencing in our overall level of ALLL to gross loans in 2015. As we anticipate continued loan growth during 2016, the level of those collectively evaluated for impairment is expected to increase provided there are no significant changes to the level of loans individually evaluated for impairment.
For further discussion of the allocation of the ALLL, see “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
Loans Past Due and Loans in Nonaccrual Status
Fluctuations in past due and nonaccrual status loans can have a significant impact on the ALLL. To determine the potential impact, and corresponding estimated losses, we analyze our historical loss trends on loans past due greater than 30 days and nonaccrual status loans. We monitor all loans that are past due and in nonaccrual status for indications of additional deterioration.
 
Total Past Due and Nonaccrual Loans

March 31
2016
 
December 31
2015
 
September 30
2015
 
June 30
2015
 
March 31
2015
Commercial and agricultural
$
2,167

 
$
2,247

 
$
1,709

 
$
2,407

 
$
4,017

Residential real estate
2,847

 
2,520

 
2,030

 
2,995

 
2,965

Consumer
28

 
31

 
60

 
126

 
106

Total
$
5,042

 
$
4,798

 
$
3,799

 
$
5,528

 
$
7,088

Total past due and nonaccrual loans to gross loans
0.58
%
 
0.56
%
 
0.45
%
 
0.66
%
 
0.87
%
Lower levels of past due and nonaccrual status loans are the result of strengthened loan performance. A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual status loans by type, is included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
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 status. The majority of new modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed on nonaccrual status may be placed back on accrual status after six months of continued performance.
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 March 31, 2016 or December 31, 2015.

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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 TDR for the:

Three Months Ended March 31, 2016
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
January 1, 2016
155

 
$
20,931

 
5

 
$
394

 
160

 
$
21,325

New modifications
3

 
28

 

 

 
3

 
28

Principal advances (payments)

 
(277
)
 

 
(8
)
 

 
(285
)
Loans paid-off
(4
)
 
(978
)
 

 

 
(4
)
 
(978
)
Partial charge-offs

 

 

 
(52
)
 

 
(52
)
Balances charged-off
(1
)
 
(15
)
 

 

 
(1
)
 
(15
)
Transfers to OREO

 

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

 

 

 

 

 

Transfers to nonaccrual status
(2
)
 
(278
)
 
2

 
278

 

 

March 31, 2016
151

 
$
19,411

 
6

 
$
577

 
157

 
$
19,988


Three Months Ended March 31, 2015
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
January 1, 2015
156

 
$
20,931

 
13

 
$
2,410

 
169

 
$
23,341

New modifications
5

 
525

 
2

 
321

 
7

 
846

Principal advances (payments)

 
(198
)
 

 
(37
)
 

 
(235
)
Loans paid-off
(8
)
 
(920
)
 
(3
)
 
(500
)
 
(11
)
 
(1,420
)
Partial charge-offs

 

 

 
(47
)
 

 
(47
)
Balances charged-off

 

 

 

 

 

Transfers to OREO

 

 
(2
)
 
(97
)
 
(2
)
 
(97
)
Transfers to accrual status

 

 

 

 

 

Transfers to nonaccrual status
(1
)
 
(83
)
 
1

 
83

 

 

March 31, 2015
152

 
$
20,255

 
11

 
$
2,133

 
163

 
$
22,388

The following table summarizes our TDRs as of:
 
March 31, 2016
 
December 31, 2015
 
 

Accruing
Interest
 
Nonaccrual
 
Total
 
Accruing
Interest
 
Nonaccrual
 
Total
 
Total
Change
Current
$
18,038

 
$
226

 
$
18,264

 
$
20,550

 
$
146

 
$
20,696

 
$
(2,432
)
Past due 30-59 days
1,373

 
130

 
1,503

 
357

 

 
357

 
1,146

Past due 60-89 days

 

 

 
24

 

 
24

 
(24
)
Past due 90 days or more

 
221

 
221

 

 
248

 
248

 
(27
)
Total
$
19,411

 
$
577

 
$
19,988

 
$
20,931

 
$
394

 
$
21,325

 
$
(1,337
)
Additional disclosures about TDRs are included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

42

Table of Contents

Impaired Loans
The following is a summary of information pertaining to impaired loans as of:
 
March 31, 2016
 
December 31, 2015

Outstanding
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
 
Outstanding
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
TDRs
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
6,539

 
$
6,778

 
$
905

 
$
7,619

 
$
7,858

 
$
818

Commercial other
177

 
188

 
2

 
188

 
199

 
11

Agricultural real estate
3,546

 
3,546

 

 
3,549

 
3,549

 

Agricultural other
519

 
519

 

 
519

 
519

 
2

Residential real estate senior liens
8,920

 
9,254

 
1,726

 
9,155

 
9,457

 
1,851

Residential real estate junior liens
132

 
132

 
26

 
133

 
133

 
28

Home equity lines of credit
121

 
421

 

 
127

 
427

 

Consumer secured
34

 
34

 

 
35

 
35

 

Total TDRs
19,988

 
20,872

 
2,659

 
21,325

 
22,177

 
2,710

Other impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
124

 
138

 
1

 
162

 
175

 

Commercial other

 

 

 

 

 

Agricultural real estate

 

 

 

 

 

Agricultural other

 

 

 

 

 

Residential real estate senior liens
912

 
1,341

 
70

 
841

 
1,308

 
108

Residential real estate junior liens
3

 
14

 
1

 
10

 
30

 
2

Home equity lines of credit

 

 

 

 
7

 

Consumer secured

 

 

 

 

 

Total other impaired loans
1,039

 
1,493

 
72

 
1,013

 
1,520

 
110

Total impaired loans
$
21,027

 
$
22,365

 
$
2,731

 
$
22,338

 
$
23,697

 
$
2,820

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

43

Table of Contents

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

March 31
2016
 
December 31
2015
 
September 30
2015
 
June 30
2015
 
March 31
2015
Nonaccrual status loans
$
1,016

 
$
792

 
$
796

 
$
1,530

 
$
3,422

Accruing loans past due 90 days or more
55

 

 

 
19

 
173

Total nonperforming loans
1,071

 
792

 
796

 
1,549

 
3,595

Foreclosed assets
276

 
421

 
601

 
873

 
717

Total nonperforming assets
$
1,347

 
$
1,213

 
$
1,397

 
$
2,422

 
$
4,312

Nonperforming loans as a % of total loans
0.12
%
 
0.09
%
 
0.10
%
 
0.19
%
 
0.44
%
Nonperforming assets as a % of total assets
0.08
%
 
0.07
%
 
0.09
%
 
0.15
%
 
0.27
%
After a loan is 90 days past due, it is placed on nonaccrual status unless it is well secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Loans may be placed back on accrual status after six months of continued performance. Total nonperforming loans continue to improve with current levels reflecting historic lows.
Included in the nonaccrual loan balances above were loans currently classified as TDRs as of:

March 31
2016
 
December 31
2015
Commercial and agricultural
$
226

 
$
232

Residential real estate
351

 
162

Total
$
577

 
$
394

Additional disclosures about nonaccrual status loans are included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recording of a charge-off. We believe that we have identified all impaired loans as of March 31, 2016.
We believe that the level of the ALLL is appropriate as of March 31, 2016. We will continue to closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at the appropriate level.

44

Table of Contents

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

Three Months Ended March 31
 
 
 
 
 
Change
 
2016
 
2015
 
$
 
%
Service charges and fees
 
 
 
 
 
 
 
ATM and debit card fees
$
597

 
$
526

 
$
71

 
13.50
 %
NSF and overdraft fees
418

 
447

 
(29
)
 
(6.49
)%
Freddie Mac servicing fee
183

 
179

 
4

 
2.23
 %
Service charges on deposit accounts
85

 
82

 
3

 
3.66
 %
Net OMSR income (loss)
(102
)
 
(104
)
 
2

 
N/M

All other
32

 
33

 
(1
)
 
(3.03
)%
Total service charges and fees
1,213

 
1,163

 
50

 
4.30
 %
Net gain on sale of mortgage loans
82

 
149

 
(67
)
 
(44.97
)%
Earnings on corporate owned life insurance policies
188

 
187

 
1

 
0.53
 %
Other
 
 
 
 
 
 
 
Trust and brokerage advisory fees
526

 
512

 
14

 
2.73
 %
Other
214

 
117

 
97

 
82.91
 %
Total other
740

 
629

 
111

 
17.65
 %
Total noninterest income
$
2,223

 
$
2,128

 
$
95

 
4.46
 %
Significant changes in noninterest income are detailed below:
ATM and debit card fees have increased as a result of marketing incentives. While we do not anticipate significant changes to our ATM and debit fees, we do expect that fees will continue to increase in the remainder of 2016 as the usage of ATM and debit cards continues to increase.
NSF and overdraft fees fluctuate from period-to-period based on customer activity as well as the number of business days in the period. We anticipate NSF and overdraft fees in 2016 to approximate 2015 levels.
Offering rates on residential mortgage loans, decline in loan demand, and increased prepayment speeds have been the most significant drivers behind fluctuations in the gain on sale of mortgage loans and net OMSR income (loss). Mortgage rates are expected to approximate current levels in the foreseeable future and purchase money mortgage activity is anticipated to increase as a result of our various initiatives to drive growth. As such, we anticipate increases in origination volumes and in turn, gains on sale of mortgage loans if these loans are sold to the secondary market.
The fluctuations in all other income is spread throughout various categories, none of which are individually significant.

45

Table of Contents

Significant noninterest expense account balances are highlighted in the following table with additional descriptions of significant fluctuations:

Three Months Ended March 31
 
 
 
 
 
Change
 
2016
 
2015
 
$
 
%
Compensation and benefits
 
 
 
 
 
 
 
Employee salaries
$
3,394

 
$
3,441

 
$
(47
)
 
(1.37
)%
Employee benefits
1,394

 
1,325

 
69

 
5.21
 %
Total compensation and benefits
4,788

 
4,766

 
22

 
0.46
 %
Furniture and equipment
 
 
 
 
 
 
 
Service contracts
720

 
671

 
49

 
7.30
 %
Depreciation
533

 
475

 
58

 
12.21
 %
ATM and debit card fees
189

 
155

 
34

 
21.94
 %
All other
26

 
13

 
13

 
100.00
 %
Total furniture and equipment
1,468

 
1,314

 
154

 
11.72
 %
Occupancy
 
 
 
 
 
 
 
Depreciation
194

 
179

 
15

 
8.38
 %
Outside services
193

 
189

 
4

 
2.12
 %
Property taxes
145

 
132

 
13

 
9.85
 %
Utilities
141

 
160

 
(19
)
 
(11.88
)%
All other
85

 
61

 
24

 
39.34
 %
Total occupancy
758

 
721

 
37

 
5.13
 %
Other
 
 
 
 
 
 
 
Director fees
209

 
198

 
11

 
5.56
 %
FDIC insurance premiums
205

 
212

 
(7
)
 
(3.30
)%
Audit and related fees
159

 
184

 
(25
)
 
(13.59
)%
Marketing costs
155

 
112

 
43

 
38.39
 %
Education and travel
123

 
92

 
31

 
33.70
 %
Donations and community relations
111

 
143

 
(32
)
 
(22.38
)%
Loan underwriting fees
108

 
88

 
20

 
22.73
 %
Consulting fees
173

 
84

 
89

 
105.95
 %
Postage and freight
106

 
98

 
8

 
8.16
 %
Printing and supplies
78

 
102

 
(24
)
 
(23.53
)%
All other
639

 
561

 
78

 
13.90
 %
Total other
2,066

 
1,874

 
192

 
10.25
 %
Total noninterest expenses
$
9,080

 
$
8,675

 
$
405

 
4.67
 %
Significant changes in noninterest expenses are detailed below:
We acquired two branches in mid-2015 which resulted in increased expenses in 2016 for most of the categories presented above. None of the increases are individually significant with the exception of marketing costs due to increased marketing efforts within the new markets.
We place a strong emphasis on employee development through continuous education. Education and travel expenses vary from year to year based on the timing of various programs that our employees attend.
We have consistently been a strong supporter of the various communities, schools, and charities in the markets we serve. Donations and community relations fluctuate from period-to-period with 2016 expenses expected to approximate 2015 levels.
Consulting fees in 2016 increased as a result of outsourced operational functions related to our trust and investment services. As such, fees are expected to increase during 2016 and exceed 2015 levels.
The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.

46

Table of Contents

Analysis of Changes in Financial Condition

March 31
2016
 
December 31
2015
 
$ Change
 
% Change
(unannualized)
ASSETS
 
 
 
 
 
 
 
Cash and cash equivalents
$
28,127

 
$
21,569

 
$
6,558

 
30.40
 %
AFS securities
 
 
 
 
 
 
 
Amortized cost of AFS securities
636,797

 
654,348

 
(17,551
)
 
(2.68
)%
Unrealized gains (losses) on AFS securities
13,062

 
5,788

 
7,274

 
125.67
 %
AFS securities
649,859

 
660,136

 
(10,277
)
 
(1.56
)%
Mortgage loans AFS
1,240

 
1,187

 
53

 
4.47
 %
Loans
 
 
 
 


 
 
Gross loans
870,291

 
850,492

 
19,799

 
2.33
 %
Less allowance for loan and lease losses
7,500

 
7,400

 
100

 
1.35
 %
Net loans
862,791

 
843,092

 
19,699

 
2.34
 %
Premises and equipment
28,269

 
28,331

 
(62
)
 
(0.22
)%
Corporate owned life insurance policies
26,611

 
26,423

 
188

 
0.71
 %
Accrued interest receivable
6,995

 
6,269

 
726

 
11.58
 %
Equity securities without readily determinable fair values
22,226

 
22,286

 
(60
)
 
(0.27
)%
Goodwill and other intangible assets
48,785

 
48,828

 
(43
)
 
(0.09
)%
Other assets
6,915

 
9,991

 
(3,076
)
 
(30.79
)%
TOTAL ASSETS
$
1,681,818

 
$
1,668,112

 
$
13,706

 
0.82
 %
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Deposits
$
1,173,507

 
$
1,164,563

 
$
8,944

 
0.77
 %
Borrowed funds
307,896

 
309,732

 
(1,836
)
 
(0.59
)%
Accrued interest payable and other liabilities
10,168

 
9,846

 
322

 
3.27
 %
Total liabilities
1,491,571

 
1,484,141

 
7,430

 
0.50
 %
Shareholders’ equity
190,247

 
183,971

 
6,276

 
3.41
 %
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,681,818

 
$
1,668,112

 
$
13,706

 
0.82
 %
The following table outlines the changes in loans:

March 31
2016
 
December 31
2015
 
$ Change
 
% Change
(unannualized)
Commercial
$
470,305

 
$
448,381

 
$
21,924

 
4.89
 %
Agricultural
115,686

 
115,911

 
(225
)
 
(0.19
)%
Residential real estate
249,318

 
251,501

 
(2,183
)
 
(0.87
)%
Consumer
34,982

 
34,699

 
283

 
0.82
 %
Total
$
870,291

 
$
850,492

 
$
19,799

 
2.33
 %
The following table displays loan balances as of:

March 31
2016
 
December 31
2015
 
September 30
2015
 
June 30
2015
 
March 31
2015
Commercial
$
470,305

 
$
448,381

 
$
434,823

 
$
432,641

 
$
419,722

Agricultural
115,686

 
115,911

 
116,293

 
113,134

 
107,299

Residential real estate
249,318

 
251,501

 
251,324

 
251,679

 
259,034

Consumer
34,982

 
34,699

 
34,231

 
34,377

 
32,438

Total
$
870,291

 
$
850,492

 
$
836,671

 
$
831,831

 
$
818,493


47

Table of Contents

While competition for commercial loans continues to be strong, we experienced growth in this segment of the portfolio during the first quarter of 2016 and anticipate continued growth in the remainder of 2016. Residential real estate loans were relatively flat and we anticipate growth in the remainder of 2016 as a result of initiatives designed to increase loan volume and the number of originations.
The following table outlines the changes in deposits:

March 31
2016
 
December 31
2015
 
$ Change
 
% Change
(unannualized)
Noninterest bearing demand deposits
$
183,820

 
$
191,376

 
$
(7,556
)
 
(3.95
)%
Interest bearing demand deposits
215,327

 
212,666

 
2,661

 
1.25
 %
Savings deposits
352,115

 
337,641

 
14,474

 
4.29
 %
Certificates of deposit
323,350

 
324,101

 
(751
)
 
(0.23
)%
Brokered certificates of deposit
76,014

 
73,815

 
2,199

 
2.98
 %
Internet certificates of deposit
22,881

 
24,964

 
(2,083
)
 
(8.34
)%
Total
$
1,173,507

 
$
1,164,563

 
$
8,944

 
0.77
 %
The following table displays deposit balances as of:

March 31
2016
 
December 31
2015
 
September 30
2015
 
June 30
2015
 
March 31
2015
Noninterest bearing demand deposits
$
183,820

 
$
191,376

 
$
181,782

 
$
182,259

 
$
176,160

Interest bearing demand deposits
215,327

 
212,666

 
197,476

 
193,680

 
197,364

Savings deposits
352,115

 
337,641

 
316,590

 
278,105

 
286,741

Certificates of deposit
323,350

 
324,101

 
328,806

 
330,226

 
333,554

Brokered certificates of deposit
76,014

 
73,815

 
76,948

 
78,853

 
76,671

Internet certificates of deposit
22,881

 
24,964

 
26,401

 
27,346

 
28,165

Total
$
1,173,507

 
$
1,164,563

 
$
1,128,003

 
$
1,090,469

 
$
1,098,655

Deposit demand continues to be driven by non-contractual deposits while certificates of deposit gradually decline. Our significant growth in savings deposits during 2015 is the result of branch acquisitions. Growth is anticipated to continue to come in the form of non-contractual deposits, while certificates of deposit are expected to continue to decline but at a slower rate than the previous year.
The current interest rate environment has made it almost impossible to increase net interest income without increasing earning assets. When deposit growth outpaced loan demand, we deployed funds from deposit growth into purchases of AFS securities to provide additional interest income. In addition to utilizing deposits, we have also utilized 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:

March 31
2016
 
December 31
2015
 
September 30
2015
 
June 30
2015
 
March 31
2015
Government sponsored enterprises
$
24,428

 
$
24,345

 
$
24,368

 
$
24,203

 
$
24,397

States and political subdivisions
231,472

 
232,217

 
232,374

 
216,647

 
222,479

Auction rate money market preferred
2,807

 
2,866

 
2,707

 
2,719

 
2,775

Preferred stocks
3,346

 
3,299

 
3,192

 
3,230

 
6,324

Mortgage-backed securities
258,284

 
263,384

 
234,258

 
210,194

 
201,997

Collateralized mortgage obligations
129,522

 
134,025

 
131,713

 
138,325

 
147,236

Total
$
649,859

 
$
660,136

 
$
628,612

 
$
595,318

 
$
605,208


48

Table of Contents

The following table displays borrowed funds balances as of:

March 31
2016
 
December 31
2015
 
September 30
2015
 
June 30
2015
 
March 31
2015
FHLB advances
$
245,000

 
$
235,000

 
$
215,000

 
$
240,000

 
$
217,000

Securities sold under agreements to repurchase without stated maturity dates
58,096

 
70,532

 
69,510

 
67,599

 
66,321

Federal funds purchased
4,800

 
4,200

 
13,100

 

 

Total
$
307,896

 
$
309,732

 
$
297,610

 
$
307,599

 
$
283,321

Capital
Capital consists solely of common stock, retained earnings, and accumulated other comprehensive income (loss). We are authorized to raise capital through dividend reinvestment, employee and director stock purchases, and shareholder stock purchases. Pursuant to these authorizations, we issued 37,465 shares or $1,072 of common stock during the first three months of 2016, as compared to 41,217 shares or $945 of common stock during the same period in 2015. 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 $158 and $146 during the three month periods ended March 31, 2016 and 2015, respectively.
We have approved a publicly announced common stock repurchase plan. Pursuant to this plan, we repurchased 28,253 shares or $799 of common stock compared to 35,671 shares for $820 during the first three months of 2016 and 2015, respectively. As of March 31, 2016, we were authorized to repurchase up to an additional 130,405 shares of common stock.
The FRB has established minimum risk based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital. On July 2, 2013, the FRB published revised BASEL III Capital standards for banks. The final rules redefine what is included or deducted from equity capital, changes risk weighting for certain on and off-balance sheet assets, increases the minimum required equity capital to be considered well capitalized, and introduces a capital cushion buffer. The rules, which are being gradually phased in between 2015 and 2019, are not expected to have a material impact on the Corporation but will require us to hold more capital than we have historically.
There are no significant regulatory constraints placed on our capital. The FRB’s current recommended minimum primary capital to assets requirement is 6.00%. Our primary capital to adjusted average assets, or tier 1 leverage ratio, was 8.44% as of March 31, 2016.
Effective January 1, 2015, the minimum standard for primary, or tier 1, capital increased from 4.00% to 6.00%. The minimum standard for total capital remains at 8.00%. Also effective January 1, 2015 is the new common equity tier 1 capital ratio which has a minimum requirement of 4.50%. The following table sets forth the percentages required under the Risk Based Capital guidelines and our values as of:

March 31
2016
 
December 31
2015
 
Required
Common equity tier 1 capital
13.24
%
 
13.44
%
 
4.50
%
 
 
 
 
 
 
Tier 1 capital
13.24
%
 
13.44
%
 
6.00
%
Tier 2 capital
0.73
%
 
0.73
%
 
2.00
%
Total Capital
13.97
%
 
14.17
%
 
8.00
%
Tier 2 capital, or secondary capital, includes only the ALLL. The percentage for the secondary capital under the required column is the maximum amount allowed from all sources.
The FRB and FDIC also prescribe minimum capital requirements for Isabella Bank. At March 31, 2016, the Bank exceeded these minimum capital requirements.

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Table of Contents

Contractual Obligations and Loan Commitments
We are party to credit related financial instruments with off-balance-sheet risk. These financial instruments are entered into in the normal course of business to meet the financing needs of our customers. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of these instruments reflect the extent of involvement we have in a particular class of financial instrument.
The following table summarizes our credit related financial instruments with off-balance-sheet risk as of:

March 31
2016
 
December 31
2015
Unfunded commitments under lines of credit
$
141,658

 
$
134,412

Commitments to grant loans
65,951

 
53,946

Commercial and standby letters of credit
937

 
915

Total
$
208,546

 
$
189,273

Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. These commitments may expire without being drawn upon and do not necessarily represent future cash requirements.
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 residential mortgage loans with the majority being 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. 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, OMSR, and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets.
For further information regarding fair value measurements see “Note 11 – Fair Value” of our notes to the interim condensed consolidated financial statements.
Liquidity
Liquidity is monitored regularly by our Market Risk Committee, which consists of members of senior management. The committee reviews projected cash flows, key ratios, and liquidity available from both primary and secondary sources.
Our primary sources of liquidity are cash and cash equivalents and AFS securities. These categories totaled $677,986 or 40.31% of assets as of March 31, 2016 as compared to $681,705 or 40.87% as of December 31, 2015. 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.

50

Table of Contents

Our primary source of funds is through deposit accounts. We also have the ability to borrow from the FHLB, the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As of March 31, 2016, we had available lines of credit of $107,598.
The following table summarizes our sources and uses of cash for the three month periods ended March 31:
 
2016
 
2015
 
$ Variance
Net cash provided by (used in) operating activities
$
4,675

 
$
2,026

 
$
2,649

Net cash provided by (used in) investing activities
(3,529
)
 
(16,788
)
 
13,259

Net cash provided by (used in) financing activities
5,412

 
16,033

 
(10,621
)
Increase (decrease) in cash and cash equivalents
6,558

 
1,271

 
5,287

Cash and cash equivalents January 1
21,569

 
19,906

 
1,663

Cash and cash equivalents March 31
$
28,127

 
$
21,177

 
$
6,950

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, loan prepayments, and changes in funding sources. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies.
Our interest rate sensitivity is estimated by first forecasting the next 12 and 24 months of net interest income under an assumed environment of a constant balance sheet and constant market interest rates (base case). We then compare the results of various simulation analyses to the base case. At March 31, 2016, 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.

51

Table of Contents

The following tables summarize our interest rate sensitivity for the 12 and 24 months as of:

March 31, 2016

12 Months

24 Months
Immediate basis point change assumption (short-term)
-100
 
+100
 
+200
 
+300
 
+400
 
-100
 
+100
 
+200
 
+300
 
+400
Percent change in net interest income vs. constant rates
(2.14
)%
 
0.78
%
 
1.67
%
 
1.93
%
 
2.42
%
 
(1.64
)%
 
1.14
%
 
2.90
%
 
3.67
%
 
4.58
%
 
December 31, 2015
 
12 Months
 
24 Months
Immediate basis point change assumption (short-term)
-100
 
+100
 
+200
 
+300
 
+400
 
-100
 
+100
 
+200
 
+300
 
+400
Percent change in net interest income vs. constant rates
(2.08
)%
 
1.27
%
 
2.00
%
 
2.11
%
 
2.23
%
 
(1.77
)%
 
2.00
%
 
3.47
%
 
4.02
%
 
4.39
%
The following tables provide information about assets and liabilities that are sensitive to changes in interest rates as of March 31, 2016 and December 31, 2015. The principal amounts of investments, loans, other interest earning assets, borrowings, and time deposits maturing were calculated based on the contractual maturity dates. Estimated cash flows for savings and NOW accounts are based on our estimated deposit decay rates.

March 31, 2016
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
 
Total
 
Fair Value
Rate sensitive assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest bearing assets
$
11,457

 
$

 
$

 
$

 
$

 
$

 
$
11,457

 
$
11,456

Average interest rates
0.04
%
 
%
 
%
 
%
 
%
 
%
 
0.04
%
 
 
AFS securities
$
172,251

 
$
102,215

 
$
77,930

 
$
68,877

 
$
70,050

 
$
158,536

 
$
649,859

 
$
649,859

Average interest rates
2.00
%
 
2.19
%
 
2.11
%
 
2.26
%
 
2.39
%
 
2.29
%
 
2.18
%
 
 
Fixed interest rate loans (1)
$
127,134

 
$
120,745

 
$
99,780

 
$
92,816

 
$
87,306

 
$
175,073

 
$
702,854

 
$
693,666

Average interest rates
4.54
%
 
4.32
%
 
4.30
%
 
4.27
%
 
4.24
%
 
4.25
%
 
4.32
%
 
 
Variable interest rate loans (1)
$
62,220

 
$
24,993

 
$
22,743

 
$
15,136

 
$
14,742

 
$
27,603

 
$
167,437

 
$
167,437

Average interest rates
4.51
%
 
4.31
%
 
4.24
%
 
3.62
%
 
3.70
%
 
3.69
%
 
4.16
%
 
 
Rate sensitive liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate borrowed funds
$
102,896

 
$
60,000

 
$
60,000

 
$
20,000

 
$
10,000

 
$
40,000

 
$
292,896

 
$
296,927

Average interest rates
0.76
%
 
1.96
%
 
2.01
%
 
1.60
%
 
1.98
%
 
2.67
%
 
1.62
%
 
 
Variable rate borrowed funds
$
15,000

 
$

 
$

 
$

 
$

 
$

 
$
15,000

 
$
15,000

Average interest rates
0.76
%
 
%
 
%
 
%
 
%
 
%
 
0.76
%
 
 
Savings and NOW accounts
$
82,197

 
$
43,136

 
$
38,732

 
$
34,809

 
$
31,317

 
$
337,251

 
$
567,442

 
$
567,442

Average interest rates
0.59
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.10
%
 
0.18
%
 
 
Fixed interest rate certificates of deposit
$
198,667

 
$
73,494

 
$
63,312

 
$
26,590

 
$
33,997

 
$
23,635

 
$
419,695

 
$
419,499

Average interest rates
0.93
%
 
1.22
%
 
1.28
%
 
1.53
%
 
1.59
%
 
1.84
%
 
1.18
%
 
 
Variable interest rate certificates of deposit
$
1,088

 
$
1,462

 
$

 
$

 
$

 
$

 
$
2,550

 
$
2,550

Average interest rates
0.52
%
 
0.66
%
 
%
 
%
 
%
 
%
 
0.60
%
 
 

52

Table of Contents


December 31, 2015
 
2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
 
Total
 
Fair Value
Rate sensitive assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest bearing assets
$
2,659

 
$
100

 
$

 
$

 
$

 
$

 
$
2,759

 
$
2,758

Average interest rates
0.23
%
 
0.35
%
 
%
 
%
 
%
 
%
 
0.24
%
 
 
AFS securities
$
148,692

 
$
120,692

 
$
81,726

 
$
73,541

 
$
71,083

 
$
164,402

 
$
660,136

 
$
660,136

Average interest rates
2.16
%
 
2.11
%
 
2.18
%
 
2.25
%
 
2.37
%
 
2.43
%
 
2.25
%
 
 
Fixed interest rate loans (1)
$
116,143

 
$
130,873

 
$
103,265

 
$
83,457

 
$
91,436

 
$
156,784

 
$
681,958

 
$
670,864

Average interest rates
4.56
%
 
4.42
%
 
4.27
%
 
4.36
%
 
4.18
%
 
4.28
%
 
4.35
%
 
 
Variable interest rate loans (1)
$
61,672

 
$
24,289

 
$
24,359

 
$
14,398

 
$
16,842

 
$
26,974

 
$
168,534

 
$
168,534

Average interest rates
4.08
%
 
4.12
%
 
4.19
%
 
3.45
%
 
3.40
%
 
3.69
%
 
3.92
%
 
 
Rate sensitive liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate borrowed funds
$
104,732

 
$
50,000

 
$
50,000

 
$
40,000

 
$
10,000

 
$
40,000

 
$
294,732

 
$
297,495

Average interest rates
0.47
%
 
1.56
%
 
2.16
%
 
2.35
%
 
1.98
%
 
2.67
%
 
1.55
%
 
 
Variable rate borrowed funds
$
15,000

 
$

 
$

 
$

 
$

 
$

 
$
15,000

 
$
15,000

Average interest rates
0.62
%
 
%
 
%
 
%
 
%
 
%
 
0.62
%
 
 
Savings and NOW accounts
$
80,242

 
$
42,064

 
$
37,773

 
$
33,950

 
$
30,548

 
$
325,730

 
$
550,307

 
$
550,307

Average interest rates
0.59
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.18
%
 
 
Fixed interest rate certificates of deposit
$
190,500

 
$
89,689

 
$
63,167

 
$
23,883

 
$
33,012

 
$
21,028

 
$
421,279

 
$
419,828

Average interest rates
0.92
%
 
1.26
%
 
1.27
%
 
1.50
%
 
1.59
%
 
1.84
%
 
1.18
%
 
 
Variable interest rate certificates of deposit
$
1,358

 
$
243

 
$

 
$

 
$

 
$

 
$
1,601

 
$
1,601

Average interest rates
0.49
%
 
0.40
%
 
%
 
%
 
%
 
%
 
0.48
%
 
 
 (1) The fair value reported is exclusive of the allocation of the ALLL.
We do not believe that there has been a material change in the nature or categories of our primary market risk exposure, or the particular markets that present the primary risk of loss. As of the date of this report, we do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term and we do not expect to make material changes in those methods 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 March 31, 2016, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as of March 31, 2016, 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.


54

Table of Contents

PART II – OTHER INFORMATION
Item 1. Legal Proceedings.
We are not involved in any material legal proceedings. We are involved in ordinary, routine litigation incidental to our business; however, no such routine proceedings are expected to result in any material adverse effect on operations, earnings, financial condition, or cash flows.
Item 1A. Risk Factors.
There have been no material changes to the risk factors disclosed in Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2015.
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 September 23, 2015, to allow for the repurchase of an additional 200,000 shares of common stock after that date. These authorizations do not have expiration dates. As common shares are repurchased under this plan, they are retired and revert back to the status of authorized, but unissued common shares.
The following table provides information for the three month period ended March 31, 2016, with respect to this plan:
 
Common Shares Repurchased
 
Total Number of Common Shares Purchased as Part of Publicly Announced Plan or Program
 
Maximum Number of Common Shares That May Yet Be Purchased Under the Plans or Programs

Number
 
Average Price
Per Common Share
 
 
Balance, December 31
 
 
 
 
 
 
158,658

January 1 - 31
12,874

 
$
28.43

 
12,874

 
145,784

February 1 - 29
11,672

 
28.36

 
11,672

 
134,112

March 1 - 31
3,707

 
27.79

 
3,707

 
130,405

Balance, March 31
28,253

 
$
28.32

 
28,253

 
130,405

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

55

Table of Contents

Item 6. Exhibits.
(a) Exhibits
Exhibit Number
 
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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Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Isabella Bank Corporation
 
 
 
 
Date:
May 9, 2016
 
 
/s/ Jae A. Evans
 
 
 
 
Jae A. Evans
 
 
 
 
Chief Executive Officer
 
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
May 9, 2016
 
 
/s/ Dennis P. Angner
 
 
 
 
Dennis P. Angner
 
 
 
 
President, Chief Financial Officer
 
 
 
 
(Principal Financial Officer, Principal Accounting Officer)

57