ISABELLA BANK Corp - Quarter Report: 2017 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, 2017



¨	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File Number: 0-18415

Isabella Bank Corporation

(Exact name of registrant as specified in its charter)



Michigan		38-2830092
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

401 N. Main St, Mt. Pleasant, MI		48858
(Address of principal executive offices)		(Zip code)

(989) 772-9471

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ý Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ý Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer	¨	Accelerated filer	ý

Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	¨

		Emerging growth company	¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.			¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes ý No

The number of common shares outstanding of the registrant’s Common Stock (no par value) was 7,847,317 as of May 3, 2017.

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ISABELLA BANK CORPORATION

QUARTERLY REPORT ON FORM 10-Q

Table of Contents



PART I – FINANCIAL INFORMATION		4

Item 1.	Financial Statements	4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	35

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	54

Item 4.	Controls and Procedures	54

PART II – OTHER INFORMATION		55

Item 1.	Legal Proceedings	55

Item 1A.	Risk Factors	55

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	55

Item 3.	Defaults Upon Senior Securities	55

Item 4.	Mine Safety Disclosures	55

Item 5.	Other Information	55

Item 6.	Exhibits	56

SIGNATURES		57

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Forward Looking Statements

This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward looking statements to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, and are included in this statement for purposes of these safe harbor provisions. Forward looking statements, which are based on certain assumptions and describe future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, monetary and fiscal policy, the quality or composition of the loan or investment portfolios, demand for loan products, fluctuation in the value of collateral securing our loan portfolio, deposit flows, competition, demand for financial services in our market area, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward looking statements and undue reliance should not be placed on such statements. Further information concerning our business, including additional factors that could materially affect our financial results, is included in our filings with the SEC.

Glossary of Acronyms and Abbreviations

The acronyms and abbreviations identified below may be used throughout this Quarterly Report on Form 10-Q, or in our other SEC filings. You may find it helpful to refer back to this page while reading this report.



AFS: Available-for-sale		GAAP: U.S. generally accepted accounting principles
ALLL: Allowance for loan and lease losses		GLB Act: Gramm-Leach-Bliley Act of 1999
AOCI: Accumulated other comprehensive income		IFRS: International Financial Reporting Standards
ASC: FASB Accounting Standards Codification		IRR: Interest rate risk
ASU: FASB Accounting Standards Update		ISDA: International Swaps and Derivatives Association
ATM: Automated Teller Machine		JOBS Act: Jumpstart our Business Startups Act
BHC Act: Bank Holding Company Act of 1956		LIBOR: London Interbank Offered Rate
CFPB: Consumer Financial Protection Bureau		N/A: Not applicable
CIK: Central Index Key		N/M: Not meaningful
CRA: Community Reinvestment Act		NASDAQ: NASDAQ Stock Market Index
DIF: Deposit Insurance Fund		NASDAQ Banks: NASDAQ Bank Stock Index
DIFS: Department of Insurance and Financial Services		NAV: Net asset value
Directors Plan: Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors		NOW: Negotiable order of withdrawal
Dividend Reinvestment Plan: Isabella Bank Corporation Stockholder Dividend Reinvestment Plan and Employee Stock Purchase Plan		NSF: Non-sufficient funds
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010		OCI: Other comprehensive income (loss)
ESOP: Employee Stock Ownership Plan		OMSR: Originated mortgage servicing rights
Exchange Act: Securities Exchange Act of 1934		OREO: Other real estate owned
FASB: Financial Accounting Standards Board		OTTI: Other-than-temporary impairment
FDI Act: Federal Deposit Insurance Act		PBO: Projected benefit obligation
FDIC: Federal Deposit Insurance Corporation		PCAOB: Public Company Accounting Oversight Board
FFIEC: Federal Financial Institutions Examinations Council		Rabbi Trust: A trust established to fund the Directors Plan
FRB: Federal Reserve Bank		SEC: U.S. Securities & Exchange Commission
FHLB: Federal Home Loan Bank		SOX: Sarbanes-Oxley Act of 2002
Freddie Mac: Federal Home Loan Mortgage Corporation		TDR: Troubled debt restructuring
FTE: Fully taxable equivalent		XBRL: eXtensible Business Reporting Language

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(Dollars in thousands)



	March 31 2017			December 31 2016
ASSETS
Cash and cash equivalents
Cash and demand deposits due from banks	$	17,525		$	20,167
Interest bearing balances due from banks	535			2,727
Total cash and cash equivalents	18,060			22,894
AFS securities (amortized cost of $587,989 in 2017 and $557,648 in 2016)	590,114			558,096
Mortgage loans AFS	1,768			1,816
Loans
Commercial	576,822			575,664
Agricultural	126,049			126,492
Residential real estate	267,141			266,050
Consumer	42,908			42,409
Gross loans	1,012,920			1,010,615
Less allowance for loan and lease losses	7,500			7,400
Net loans	1,005,420			1,003,215
Premises and equipment	28,982			29,314
Corporate owned life insurance policies	26,480			26,300
Accrued interest receivable	7,046			6,580
Equity securities without readily determinable fair values	21,616			21,694
Goodwill and other intangible assets	48,635			48,666
Other assets	12,739			13,576
TOTAL ASSETS	$	1,760,860		$	1,732,151
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest bearing	$	207,448		$	205,071
NOW accounts	216,975			209,325
Certificates of deposit under $100 and other savings	533,015			520,219
Certificates of deposit over $100	273,623			260,425
Total deposits	1,231,061			1,195,040
Borrowed funds	327,375			337,694
Accrued interest payable and other liabilities	11,448			11,518
Total liabilities	1,569,884			1,544,252
Shareholders’ equity
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,843,120 shares (including 21,606 shares held in the Rabbi Trust) in 2017 and 7,821,069 shares (including 26,042 shares held in the Rabbi Trust) in 2016	140,171			139,525
Shares to be issued for deferred compensation obligations	5,048			5,038
Retained earnings	47,297			46,114
Accumulated other comprehensive income (loss)	(1,540		)	(2,778		)
Total shareholders’ equity	190,976			187,899
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,760,860		$	1,732,151

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

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(Dollars in thousands except per share amounts)



	Three Months Ended March 31
	2017		2016
Interest income
Loans, including fees	$	10,120	$	9,038
AFS securities
Taxable	2,151		2,400
Nontaxable	1,415		1,485
Federal funds sold and other	175		158
Total interest income	13,861		13,081
Interest expense
Deposits	1,540		1,399
Borrowings	1,291		1,215
Total interest expense	2,831		2,614
Net interest income	11,030		10,467
Provision for loan losses	27		156
Net interest income after provision for loan losses	11,003		10,311
Noninterest income
Service charges and fees	1,530		1,213
Net gain on sale of mortgage loans	155		82
Earnings on corporate owned life insurance policies	180		188
Other	751		740
Total noninterest income	2,616		2,223
Noninterest expenses
Compensation and benefits	5,676		4,788
Furniture and equipment	1,560		1,480
Occupancy	837		810
Other	1,878		2,002
Total noninterest expenses	9,951		9,080
Income before federal income tax expense	3,668		3,454
Federal income tax expense	532		437
NET INCOME	$	3,136	$	3,017
Earnings per common share
Basic	$	0.40	$	0.39
Diluted	$	0.39	$	0.38
Cash dividends per common share	$	0.25	$	0.24

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

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(Dollars in thousands)



	Three Months Ended March 31
	2017			2016
Net income	$	3,136		$	3,017
Unrealized gains (losses) on AFS securities arising during the period	1,677			7,274
Tax effect (1)	(450		)	(2,477		)
Unrealized gains (losses) on AFS securities, net of tax	1,227			4,797
Unrealized gains (losses) on derivative instruments arising during the period	17			—
Tax effect (1)	(6		)	—
Unrealized gains (losses) on derivative instruments, net of tax	11			—
Other comprehensive income, net of tax	1,238			4,797
Comprehensive income	$	4,374		$	7,814


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

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

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

(Dollars in thousands except per share amounts)



	Common Stock
	Common Shares Outstanding		Amount			Common Shares to be Issued for Deferred Compensation Obligations			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Totals
Balance, January 1, 2016	7,799,867		$	139,198		$	4,592		$	39,960		$	221		$	183,971
Comprehensive income (loss)	—		—			—			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
Balance, January 1, 2017	7,821,069		$	139,525		$	5,038		$	46,114		$	(2,778	)	$	187,899
Comprehensive income (loss)	—		—			—			3,136			1,238			4,374
Issuance of common stock	63,866		1,770			—			—			—			1,770
Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations	—		168			(168		)	—			—			—
Share-based payment awards under equity compensation plan	—		—			178			—			—			178
Common stock purchased for deferred compensation obligations	—		(123		)	—			—			—			(123		)
Common stock repurchased pursuant to publicly announced repurchase plan	(41,815	)	(1,169		)	—			—			—			(1,169		)
Cash dividends paid ($0.25 per common share)	—		—			—			(1,953		)	—			(1,953		)
Balance, March 31, 2017	7,843,120		$	140,171		$	5,048		$	47,297		$	(1,540	)	$	190,976

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

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Dollars in thousands)



	Three Months Ended March 31
	2017			2016
OPERATING ACTIVITIES
Net income	$	3,136		$	3,017
Reconciliation of net income to net cash provided by operating activities:
Provision for loan losses	27			156
Impairment of foreclosed assets	28			—
Depreciation	722			727
Amortization of OMSR	81			64
Amortization of acquisition intangibles	31			43
Net amortization of AFS securities	530			705
Net gain on sale of mortgage loans	(155		)	(82		)
Increase in cash value of corporate owned life insurance policies	(180		)	(188		)
Share-based payment awards under equity compensation plan	178			158
Origination of loans held-for-sale	(8,432		)	(4,499		)
Proceeds from loan sales	8,635			4,528
Net changes in operating assets and liabilities which provided (used) cash:
Accrued interest receivable	(466		)	(726		)
Other assets	322			450
Accrued interest payable and other liabilities	(70		)	322
Net cash provided by (used in) operating activities	4,387			4,675
INVESTING ACTIVITIES
Activity in AFS securities
Maturities, calls, and principal payments	19,413			19,452
Purchases	(50,284		)	(2,606		)
Net loan principal (originations) collections	(2,258		)	(19,944		)
Proceeds from sales of foreclosed assets	71			234
Purchases of premises and equipment	(390		)	(665		)
Net cash provided by (used in) investing activities	(33,448		)	(3,529		)

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Dollars in thousands)



	Three Months Ended March 31
	2017			2016
FINANCING ACTIVITIES
Net increase (decrease) in deposits	$	36,021		$	8,944
Net increase (decrease) in borrowed funds	(10,319		)	(1,836		)
Cash dividends paid on common stock	(1,953		)	(1,872		)
Proceeds from issuance of common stock	1,770			1,072
Common stock repurchased	(1,169		)	(799		)
Common stock purchased for deferred compensation obligations	(123		)	(97		)
Net cash provided by (used in) financing activities	24,227			5,412
Increase (decrease) in cash and cash equivalents	(4,834		)	6,558
Cash and cash equivalents at beginning of period	22,894			21,569
Cash and cash equivalents at end of period	$	18,060		$	28,127
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid	$	2,823		$	2,574
SUPPLEMENTAL NONCASH INFORMATION:
Transfers of loans to foreclosed assets	$	26		$	89

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

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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, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2016.

Our accounting policies are materially the same as those discussed in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2016.

Reclassifications: Certain amounts reported in the 2016 consolidated financial statements have been reclassified to conform with the 2017 presentation.

Note 2 – Computation of Earnings Per Common Share

Basic earnings per common share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued relate solely to outstanding shares in the Directors Plan.



	Three Months Ended March 31
	2017		2016
Average number of common shares outstanding for basic calculation	7,827,143		7,795,294
Average potential effect of common shares in the Directors Plan (1)	191,533		184,461
Average number of common shares outstanding used to calculate diluted earnings per common share	8,018,676		7,979,755
Net income	$	3,136	$	3,017
Earnings per common share
Basic	$	0.40	$	0.39
Diluted	$	0.39	$	0.38


⁽¹⁾	Exclusive of shares held in the Rabbi Trust

Note 3 – Accounting Standards Updates

Pending Accounting Standards Updates

ASU No. 2017-04: “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”

In January 2017, ASU No. 2017-04 modified the concept of impairment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value. An entity no longer will determine goodwill impairment by calculating the implied fair value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. Because these amendments eliminate Step 2 from the goodwill impairment test, they should reduce the cost and complexity of evaluating goodwill for impairment. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2019 and is not expected to have a significant impact on our operations or financial statement disclosures.

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ASU No. 2017-07: “Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost”

In March 2017, ASU No. 2017-07 provided guidance that requires that an employer disaggregate the service cost component from the other components of net benefit cost. The amendments also provide explicit guidance on how to present the service cost component and the other components of net benefit cost in the income statement and allow only the service cost component of net benefit cost to be eligible for capitalization. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2017 and is not expected to have a significant impact on our operations or financial statement disclosures.

ASU No. 2017-08: “Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities”

In March 2017, ASU No. 2017-08 amended the amortization period for certain purchased callable debt securities held at a premium. Under current GAAP, entities generally amortize the premium as an adjustment of yield over the contractual life of the instrument. The amendments in this update shorten the amortization period and require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. 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.

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, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Government sponsored enterprises	$	10,240	$	24	$	—	$	10,264
States and political subdivisions	218,113		4,889		225		222,777
Auction rate money market preferred	3,200		—		223		2,977
Preferred stocks	3,800		—		203		3,597
Mortgage-backed securities	231,727		629		2,582		229,774
Collateralized mortgage obligations	120,909		668		852		120,725
Total	$	587,989	$	6,210	$	4,085	$	590,114



	December 31, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Government sponsored enterprises	$	10,258	$	3	$	2	$	10,259
States and political subdivisions	208,977		4,262		320		212,919
Auction rate money market preferred	3,200		—		406		2,794
Preferred stocks	3,800		—		375		3,425
Mortgage-backed securities	229,593		581		2,918		227,256
Collateralized mortgage obligations	101,820		600		977		101,443
Total	$	557,648	$	5,446	$	4,998	$	558,096

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The amortized cost and fair value of AFS securities by contractual maturity at March 31, 2017 are as follows:



	Maturing								Securities with Variable Monthly Payments or Noncontractual Maturities
	Due in One Year or Less		After One Year But Within Five Years		After Five Years But Within Ten Years		After Ten Years				Total
Government sponsored enterprises	$	32	$	10,208	$	—	$	—	$	—	$	10,240
States and political subdivisions	26,815		72,589		83,003		35,706		—		218,113
Auction rate money market preferred	—		—		—		—		3,200		3,200
Preferred stocks	—		—		—		—		3,800		3,800
Mortgage-backed securities	—		—		—		—		231,727		231,727
Collateralized mortgage obligations	—		—		—		—		120,909		120,909
Total amortized cost	$	26,847	$	82,797	$	83,003	$	35,706	$	359,636	$	587,989
Fair value	$	26,902	$	84,659	$	85,348	$	36,132	$	357,073	$	590,114

Expected maturities for government sponsored enterprises and states and political subdivisions may differ from contractual maturities because issuers may have the right to call or prepay obligations.

As the auction rate money market preferred and preferred stocks have continual call dates, they are not reported by a specific maturity group. Because of their variable monthly payments, mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group.

The following information pertains to AFS securities with gross unrealized losses at March 31, 2017 and December 31, 2016, aggregated by investment category and length of time that individual securities have been in a continuous loss position.



	March 31, 2017
	Less Than Twelve Months				Twelve Months or More
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Total Unrealized Losses
Government sponsored enterprises	$	—	$	—	$	—	$	—	$	—
States and political subdivisions	222		21,059		3		314		225
Auction rate money market preferred	—		—		223		2,977		223
Preferred stocks	—		—		203		3,597		203
Mortgage-backed securities	2,582		168,965		—		—		2,582
Collateralized mortgage obligations	490		41,756		362		10,887		852
Total	$	3,294	$	231,780	$	791	$	17,775	$	4,085
Number of securities in an unrealized loss position:			85				9		94



	December 31, 2016
	Less Than Twelve Months				Twelve Months or More
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Total Unrealized Losses
Government sponsored enterprises	$	2	$	9,936	$	—	$	—	$	2
States and political subdivisions	311		21,800		9		355		320
Auction rate money market preferred	—		—		406		2,794		406
Preferred stocks	—		—		375		3,425		375
Mortgage-backed securities	2,918		175,212		—		—		2,918
Collateralized mortgage obligations	628		51,466		349		11,381		977
Total	$	3,859	$	258,414	$	1,139	$	17,955	$	4,998
Number of securities in an unrealized loss position:			104				9		113

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As of March 31, 2017 and December 31, 2016, we conducted an analysis to determine whether any AFS securities currently in an unrealized loss position should be other-than-temporarily impaired. Such analyses considered, among other factors, the following criteria:


•	Has the value of the investment declined more than what is deemed to be reasonable based on a risk and maturity adjusted discount rate?


•	Is the investment credit rating below investment grade?


•	Is it probable the issuer will be unable to pay the amount when due?


•	Is it more likely than not that we will have to sell the security before recovery of its cost basis?


•	Has the duration of the investment been extended?

During the fourth quarter of 2016, we identified one municipal bond as other-than-temporarily impaired. While management estimated the OTTI to be realized, we also engaged the services of an independent investment valuation firm to estimate the amount of impairment as of December 31, 2016. The valuation calculated the estimated market value utilizing two different approaches:

1) Market - Appraisal and Comparable Investments

2) Income - Discounted Cash Flow Method

The two methods were then weighted, with a higher weighting applied to the Market approach, to determine the estimated impairment. As a result of this analysis, we recognized an OTTI of $770 in earnings for the year ended December 31, 2016. Based on analysis of this bond, there was no additional OTTI recognized as of March 31, 2017.

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 other AFS securities are other-than-temporarily impaired as of March 31, 2017 or December 31, 2016, with the exception of the one municipal bond discussed above.

Note 5 – Loans and ALLL

We grant commercial, agricultural, residential real estate, and consumer loans to customers situated primarily in Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties in Michigan. The ability of the borrowers to honor their repayment obligations is often dependent upon the real estate, agricultural, manufacturing, retail, gaming, tourism, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees. A portion of loans are unsecured.

Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and any deferred fees or costs. Interest income is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the level yield method.

The accrual of interest on commercial, agricultural, and residential real estate loans is discontinued at the time the loan is 90 days or more past due unless the credit is well-secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful.

For loans that are placed on nonaccrual status or charged-off, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the ALLL. Loans may be returned to accrual status after six months of continuous performance.

Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, advances to mortgage brokers, farmland and agricultural production, and states and political subdivisions. Repayment of these loans is dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of direct credit exposure to any one borrower to $15,000. Borrowers with direct credit needs of more than $15,000 are serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans commonly require loan-to-value limits of 80% or less. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, and property and equipment. Personal guarantees are generally required

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from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we require annual financial statements, prepare cash flow analyses, and review credit reports.

We entered into a mortgage purchase program in 2016 with a financial institution where we participate in advances to mortgage brokers ("advances"). The mortgage brokers originate residential mortgage loans with the intent to sell on the secondary market. We participate in the advance to the mortgage broker, which is secured by the underlying mortgage loan, until it is ultimately sold on the secondary market. As such, the average life of each participated advance is approximately 20-30 days. Funds from the sale of the loan are used to payoff our participation in the advance to the mortgage broker. We classify these advances as commercial loans and include the outstanding balance in commercial loans on our balance sheet. Under the participation agreement, we committed to a maximum outstanding aggregate amount of $30,000. The difference between our outstanding balances and the maximum outstanding aggregate amount is classified as “Unfunded commitments under lines of credit” in the “Contractual Obligations and Loan Commitments” section of the Management's Discussion and Analysis of Financial Condition and Results of Operations of this report.

We offer adjustable rate mortgages, construction loans, and fixed rate residential real estate loans which have amortization periods up to a maximum of 30 years. We consider the anticipated direction of interest rates, balance sheet duration, the sensitivity of our balance sheet to changes in interest rates, and overall loan demand to determine whether or not to sell fixed rate loans to Freddie Mac.

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 originated 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 originated mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market underwriting system; loans in excess of $500 require the approval of our Internal Loan Committee, the Executive Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors.

Consumer loans include secured and unsecured personal loans. Loans are amortized for a period of up to 12 years based on the age and value of the underlying collateral. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market.

The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL.

The appropriateness of the ALLL is evaluated on a quarterly basis and is based upon a periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. Specific allocations for impaired loans are primarily determined based on the difference between the loan’s outstanding balance and the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell. Historical loss allocations are calculated at the loan class and segment levels based on a migration analysis of the loan portfolio, with the exception of advances to mortgage brokers, over the preceding five years. With no historical losses on advances to mortgage brokers, there is no allocation in the commercial segment displayed in the following tables based on historical loss factors. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

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A summary of changes in the ALLL and the recorded investment in loans by segments follows:



	Allowance for Loan Losses
	Three Months Ended March 31, 2017
	Commercial			Agricultural			Residential Real Estate			Consumer			Unallocated		Total
January 1, 2017	$	1,814		$	884		$	2,664		$	624		$	1,414	$	7,400
Charge-offs	(27		)	—			(43		)	(74		)	—		(144		)
Recoveries	133			—			36			48			—		217
Provision for loan losses	(149		)	(357		)	441			73			19		27
March 31, 2017	$	1,771		$	527		$	3,098		$	671		$	1,433	$	7,500



	Allowance for Loan Losses and Recorded Investment in Loans
	March 31, 2017
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
ALLL
Individually evaluated for impairment	$	697	$	—	$	1,684	$	—	$	—	$	2,381
Collectively evaluated for impairment	1,074		527		1,414		671		1,433		5,119
Total	$	1,771	$	527	$	3,098	$	671	$	1,433	$	7,500
Loans
Individually evaluated for impairment	$	7,601	$	5,549	$	8,617	$	23			$	21,790
Collectively evaluated for impairment	569,221		120,500		258,524		42,885				991,130
Total	$	576,822	$	126,049	$	267,141	$	42,908			$	1,012,920



	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
	December 31, 2016
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
ALLL
Individually evaluated for impairment	$	741	$	1	$	1,629	$	—	$	—	$	2,371
Collectively evaluated for impairment	1,073		883		1,035		624		1,414		5,029
Total	$	1,814	$	884	$	2,664	$	624	$	1,414	$	7,400
Loans
Individually evaluated for impairment	$	7,859	$	5,545	$	8,638	$	26			$	22,068
Collectively evaluated for impairment	567,805		120,947		257,412		42,383				988,547
Total	$	575,664	$	126,492	$	266,050	$	42,409			$	1,010,615

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The following table displays the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit risk ratings as of:



	March 31, 2017
	Commercial								Agricultural
	Real Estate		Other		Advances to Mortgage Brokers		Total		Real Estate		Other		Total		Total
Rating
1 - Excellent	$	27	$	342	$	—	$	369	$	—	$	—	$	—	$	369
2 - High quality	9,854		14,985		—		24,839		3,191		1,024		4,215		29,054
3 - High satisfactory	105,342		40,714		11,502		157,558		21,226		10,005		31,231		188,789
4 - Low satisfactory	309,369		72,659		—		382,028		49,021		20,015		69,036		451,064
5 - Special mention	3,566		1,279		—		4,845		8,670		5,687		14,357		19,202
6 - Substandard	5,810		1,370		—		7,180		3,799		2,878		6,677		13,857
7 - Vulnerable	3		—		—		3		—		533		533		536
8 - Doubtful	—		—		—		—		—		—		—		—
Total	$	433,971	$	131,349	$	11,502	$	576,822	$	85,907	$	40,142	$	126,049	$	702,871



	December 31, 2016
	Commercial								Agricultural
	Real Estate		Other		Advances to Mortgage Brokers		Total		Real Estate		Other		Total		Total
Rating
1 - Excellent	$	28	$	438	$	—	$	466	$	—	$	—	$	—	$	466
2 - High quality	11,821		12,091		19,688		43,600		3,566		1,426		4,992		48,592
3 - High satisfactory	103,529		41,982		—		145,511		21,657		11,388		33,045		178,556
4 - Low satisfactory	299,317		74,432		—		373,749		48,955		22,715		71,670		445,419
5 - Special mention	3,781		1,178		—		4,959		6,009		3,085		9,094		14,053
6 - Substandard	5,901		1,474		—		7,375		3,650		3,508		7,158		14,533
7 - Vulnerable	4		—		—		4		—		533		533		537
8 - Doubtful	—		—		—		—		—		—		—		—
Total	$	424,381	$	131,595	$	19,688	$	575,664	$	83,837	$	42,655	$	126,492	$	702,156

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.

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•	Access to alternative financing.


•	Well defined primary and secondary source of repayment.


•	If supported by guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident.

3. HIGH SATISFACTORY – Reasonable Risk

Credit with satisfactory financial condition and further characterized by:


•	Working capital adequate to support operations.


•	Cash flow sufficient to pay debts as scheduled.


•	Management experience and depth appear favorable.


•	Loan performing according to terms.


•	If loan is secured, collateral is acceptable and loan is fully protected.

4. LOW SATISFACTORY – Acceptable Risk

Credit with bankable risks, although some signs of weaknesses are shown:


•	Would include most start-up businesses.


•	Occasional instances of trade slowness or repayment delinquency – may have been 10-30 days slow within the past year.


•	Management’s abilities are apparent, yet unproven.


•	Weakness in primary source of repayment with adequate secondary source of repayment.


•	Loan structure generally in accordance with policy.


•	If secured, loan collateral coverage is marginal.


•	Adequate cash flow to service debt, but coverage is low.

To be classified as less than satisfactory, only one of the following criteria must be met.

5. SPECIAL MENTION – Criticized

Credit constitutes an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific loan:


•	Downward trend in sales, profit levels, and margins.


•	Impaired working capital position.


•	Cash flow is strained in order to meet debt repayment.


•	Loan delinquency (30-60 days) and overdrafts may occur.


•	Shrinking equity cushion.


•	Diminishing primary source of repayment and questionable secondary source.


•	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.

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•	Requires excessive attention of the loan officer.


•	Borrower is uncooperative with loan officer.

7. VULNERABLE – Classified

Credit is considered “Substandard” and warrants placing on nonaccrual status. Risk of loss is being evaluated and exit strategy options are under review. Other characteristics that may apply:


•	Insufficient cash flow to service debt.


•	Minimal or no payments being received.


•	Limited options available to avoid the collection process.


•	Transition status, expect action will take place to collect loan without immediate progress being made.

8. DOUBTFUL – Workout

Credit has all the weaknesses inherent in a “Substandard” loan with the added characteristic that collection and/or liquidation is pending. The possibility of a loss is extremely high, but its classification as a loss is deferred until liquidation procedures are completed, or reasonably estimable. Other characteristics that may apply:


•	Normal operations are severely diminished or have ceased.


•	Seriously impaired cash flow.


•	Original repayment terms materially altered.


•	Secondary source of repayment is inadequate.


•	Survivability as a “going concern” is impossible.


•	Collection process has begun.


•	Bankruptcy petition has been filed.


•	Judgments have been filed.


•	Portion of the loan balance has been charged-off.

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, 2017
	Accruing Interest and Past Due:								Total Past Due and Nonaccrual
	30-59 Days		60-89 Days		90 Days or More		Nonaccrual				Current		Total
Commercial
Commercial real estate	$	1,588	$	—	$	—	$	3	$	1,591	$	432,380	$	433,971
Commercial other	1,222		—		—		—		1,222		130,127		131,349
Advances to mortgage brokers	—		—		—		—		—		11,502		11,502
Total commercial	2,810		—		—		3		2,813		574,009		576,822
Agricultural
Agricultural real estate	—		471		1,197		—		1,668		84,239		85,907
Agricultural other	744		—		—		533		1,277		38,865		40,142
Total agricultural	744		471		1,197		533		2,945		123,104		126,049
Residential real estate
Senior liens	1,713		148		142		510		2,513		217,211		219,724
Junior liens	—		—		—		25		25		8,442		8,467
Home equity lines of credit	556		7		—		67		630		38,320		38,950
Total residential real estate	2,269		155		142		602		3,168		263,973		267,141
Consumer
Secured	20		—		—		—		20		39,372		39,392
Unsecured	6		9		—		—		15		3,501		3,516
Total consumer	26		9		—		—		35		42,873		42,908
Total	$	5,849	$	635	$	1,339	$	1,138	$	8,961	$	1,003,959	$	1,012,920

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	December 31, 2016
	Accruing Interest and Past Due:								Total Past Due and Nonaccrual
	30-59 Days		60-89 Days		90 Days or More		Nonaccrual				Current		Total
Commercial
Commercial real estate	$	1,580	$	—	$	35	$	4	$	1,619	$	422,762	$	424,381
Commercial other	1,693		35		—		—		1,728		129,867		131,595
Advances to mortgage brokers	—		—		—		—		—		19,688		19,688
Total commercial	3,273		35		35		4		3,347		572,317		575,664
Agricultural
Agricultural real estate	191		—		508		—		699		83,138		83,837
Agricultural other	19		—		—		533		552		42,103		42,655
Total agricultural	210		—		508		533		1,251		125,241		126,492
Residential real estate
Senior liens	1,638		174		22		498		2,332		216,681		219,013
Junior liens	15		—		—		25		40		8,317		8,357
Home equity lines of credit	270		6		68		—		344		38,336		38,680
Total residential real estate	1,923		180		90		523		2,716		263,334		266,050
Consumer
Secured	110		—		—		—		110		38,582		38,692
Unsecured	5		—		—		—		5		3,712		3,717
Total consumer	115		—		—		—		115		42,294		42,409
Total	$	5,521	$	215	$	633	$	1,060	$	7,429	$	1,003,186	$	1,010,615

Impaired Loans

Loans may be classified as impaired if they meet one or more of the following criteria:


1.	There has been a charge-off of its principal balance (in whole or in part);


2.	The loan has been classified as a TDR; or


3.	The loan is in nonaccrual status.

Impairment is measured on a loan-by-loan basis for commercial and agricultural loans by comparing the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Impairment is measured on a loan-by-loan basis for residential real estate and consumer loans by comparing the loan’s unpaid principal balance to the present value of expected future cash flows discounted at the loan’s effective interest rate.

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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, 2017						December 31, 2016
	Outstanding Balance		Unpaid Principal Balance		Valuation Allowance		Outstanding Balance		Unpaid Principal Balance		Valuation Allowance
Impaired loans with a valuation allowance
Commercial real estate	$	4,219	$	4,339	$	676	$	5,811	$	5,992	$	716
Commercial other	1,192		1,192		21		1,358		1,358		25
Agricultural real estate	—		—		—		—		—		—
Agricultural other	—		—		—		134		134		1
Residential real estate senior liens	8,376		8,960		1,668		8,464		9,049		1,615
Residential real estate junior liens	78		78		16		72		82		14
Home equity lines of credit	—		—		—		—		—		—
Consumer secured	—		—		—		—		—		—
Total impaired loans with a valuation allowance	13,865		14,569		2,381		15,839		16,615		2,371
Impaired loans without a valuation allowance
Commercial real estate	2,048		2,123				604		617
Commercial other	142		142				86		97
Agricultural real estate	4,047		4,047				4,037		4,037
Agricultural other	1,502		1,502				1,374		1,374
Home equity lines of credit	163		463				102		402
Consumer secured	23		23				26		26
Total impaired loans without a valuation allowance	7,925		8,300				6,229		6,553
Impaired loans
Commercial	7,601		7,796		697		7,859		8,064		741
Agricultural	5,549		5,549		—		5,545		5,545		1
Residential real estate	8,617		9,501		1,684		8,638		9,533		1,629
Consumer	23		23		—		26		26		—
Total impaired loans	$	21,790	$	22,869	$	2,381	$	22,068	$	23,168	$	2,371

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The following is a summary of information pertaining to impaired loans for the:



	Three Months Ended March 31
	2017				2016
	Average Outstanding Balance		Interest Income Recognized		Average Outstanding Balance		Interest Income Recognized
Impaired loans with a valuation allowance
Commercial real estate	$	5,015	$	73	$	5,758	$	84
Commercial other	1,275		24		52		1
Agricultural real estate	—		—		—		—
Agricultural other	67		—		168		—
Residential real estate senior liens	8,420		83		9,914		100
Residential real estate junior liens	75		—		139		1
Home equity lines of credit	—		—		—		—
Consumer secured	—		—		—		—
Total impaired loans with a valuation allowance	14,852		180		16,031		186
Impaired loans without a valuation allowance
Commercial real estate	1,326		33		1,465		19
Commercial other	114		2		131		2
Agricultural real estate	4,042		62		3,548		45
Agricultural other	1,438		13		352		6
Home equity lines of credit	133		5		124		4
Consumer secured	25		—		35		1
Total impaired loans without a valuation allowance	7,078		115		5,655		77
Impaired loans
Commercial	7,730		132		7,406		106
Agricultural	5,547		75		4,068		51
Residential real estate	8,628		88		10,177		105
Consumer	25		—		35		1
Total impaired loans	$	21,930	$	295	$	21,686	$	263

As of March 31, 2017 and December 31, 2016, we had $117 of commitments to advance additional funds 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:

•Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics.

•Extending the amortization period beyond typical lending guidelines for loans with similar risk characteristics.

•Forgiving principal.

•Forgiving accrued interest.

To determine if a borrower is experiencing financial difficulties, factors we consider include:


•	The borrower is currently in default on any of their debt.


•	The borrower would likely default on any of their debt if the concession was not granted.


•	The borrower’s cash flow was insufficient to service all of their debt if the concession was not granted.


•	The borrower has declared, or is in the process of declaring, bankruptcy.


•	The borrower is unlikely to continue as a going concern (if the entity is a business).

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



	Three Months Ended March 31
	2017					2016
	Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial other	2	$	227	$	227	—	$	—	$	—
Residential real estate
Senior liens	—	—		—		2	26		26
Junior liens	1	8		8		—	—		—
Total residential real estate	1	8		8		2	26		26
Consumer unsecured	—	—		—		1	2		2
Total	3	$	235	$	235	3	$	28	$	28

The following tables summarize concessions we granted to borrowers in financial difficulty for the:



	Three Months Ended March 31
	2017						2016
	Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period			Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period
	Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment
Commercial other	—	$	—	2	$	227	—	$	—	—	$	—
Residential real estate
Senior liens	—	—		—	—		2	26		—	—
Junior liens	1	8		—	—		—	—		—	—
Total residential real estate	1	8		—	—		2	26		—	—
Consumer unsecured	—	—		—	—		—	—		1	2
Total	1	$	8	2	$	227	2	$	26	1	$	2

We did not restructure any loans by forgiving principal or accrued interest in the three month periods ended March 31, 2017 or 2016.

Based on our historical loss experience, losses associated with TDRs are not significantly different than other impaired loans within the same loan segment. As such, TDRs, including TDRs that have been modified in the past 12 months that subsequently defaulted, are analyzed in the same manner as other impaired loans within their respective loan segment.

We had no loans that defaulted in the three month periods ended March 31, 2017 and March 31, 2016 which were modified within 12 months prior to the default date.

The following is a summary of TDR loan balances as of:



	March 31, 2017		December 31, 2016
TDRs	$	21,051	$	21,382

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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 2017		December 31 2016
FHLB Stock	$	11,900	$	11,900
Corporate Settlement Solutions, LLC	7,383		7,461
FRB Stock	1,999		1,999
Other	334		334
Total	$	21,616	$	21,694

Note 7 – Foreclosed Assets

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



	March 31 2017		December 31 2016
Consumer mortgage loans collateralized by residential real estate foreclosed as a result of obtaining physical possession	$	19	$	18
All other foreclosed assets	139		213
Total	$	158	$	231

Below is a summary of changes in foreclosed assets during the:



	Three Months Ended March 31
	2017			2016
Balance, January 1	$	231		$	421
Properties transferred	26			89
Impairments	(28		)	—
Proceeds from sale	(71		)	(234		)
Balance, March 31	$	158		$	276

There were $92 and $18 of consumer mortgage loans collateralized by residential real estate in the process of foreclosure as of March 31, 2017 and December 31, 2016.

Note 8 – Borrowed Funds

Borrowed funds consist of the following obligations as of:



	March 31, 2017				December 31, 2016
	Amount		Rate		Amount		Rate
FHLB advances	$	270,000	1.88	%	$	270,000	1.82	%
Securities sold under agreements to repurchase without stated maturity dates	57,375		0.13	%	60,894		0.13	%
Federal funds purchased	—		—	%	6,800		1.00	%
Total	$	327,375	1.58	%	$	337,694	1.50	%

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

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The following table lists the maturities and weighted average interest rates of FHLB advances as of:



	March 31, 2017				December 31, 2016
	Amount		Rate		Amount		Rate
Fixed rate due 2017	$	50,000	1.29	%	$	70,000	1.39	%
Fixed rate due 2018	50,000		2.16	%	50,000		2.16	%
Fixed rate due 2019	60,000		1.99	%	60,000		1.99	%
Fixed rate due 2020	20,000		1.85	%	10,000		1.98	%
Fixed rate due 2021	50,000		1.91	%	50,000		1.91	%
Variable rate due 2021 ¹	10,000		1.34	%	10,000		1.21	%
Fixed rate due 2022	10,000		2.07	%	—		—	%
Fixed rate due 2023	10,000		3.90	%	10,000		3.90	%
Fixed rate due 2026	10,000		1.17	%	10,000		1.17	%
Total	$	270,000	1.88	%	$	270,000	1.82	%


⁽¹⁾	Hedged advance (see "Derivative Instruments" section below)

Securities sold under agreements to repurchase are classified as secured borrowings and are reflected at the amount of cash received in connection with the transaction. The securities underlying the agreements have a carrying value and a fair value of $57,375 and $60,918 at March 31, 2017 and December 31, 2016, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.

Securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances generally mature within one to four days from the transaction date. The following table provides a summary of securities sold under repurchase agreements without stated maturity dates and federal funds purchased. We had no FRB Discount Window advances during the three month periods ended March 31, 2017 or 2016.



	Three Months Ended March 31
	2017						2016
	Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period		Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates	$	58,088	$	57,505	0.13	%	$	61,783	$	61,051	0.12	%
Federal funds purchased	5,200		863		0.96	%	4,800		4,696		0.69	%

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



	March 31 2017		December 31 2016
Pledged to secure borrowed funds	$	360,680	$	363,427
Pledged to secure repurchase agreements	57,375		60,918
Pledged for public deposits and for other purposes necessary or required by law	32,719		33,916
Total	$	450,774	$	458,261

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



	March 31 2017		December 31 2016
States and political subdivisions	$	3,529	$	5,676
Mortgage-backed securities	15,852		11,383
Collateralized mortgage obligations	37,994		43,859
Total	$	57,375	$	60,918

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AFS securities pledged to repurchase agreements are monitored to ensure the appropriate level is collateralized. In the event of maturities, calls, significant principal repayments, or significant decline in market values, we have adequate levels of AFS securities to pledge to satisfy required collateral.

As of March 31, 2017, we had the ability to borrow up to an additional $99,763, based on assets pledged as collateral. We had no investment securities that are restricted to be pledged for specific purposes.

Derivative Instruments

In 2016, we began to enter into interest rate swaps to manage exposure to interest rate risk and variability in cash flows. The interest rate swaps, associated with our variable rate borrowings, are designated upon inception as cash flow hedges of forecasted interest payments. We enter into LIBOR-based interest rate swaps that involve the receipt of variable amounts in exchange for fixed rate payments, in effect converting variable rate debt to fixed rate debt.

Cash flow hedges are assessed for effectiveness using regression analysis. The effective portion of changes in fair value are recorded in OCI and subsequently reclassified into interest expense in the same period in which the related interest on the variable rate borrowings affects earnings. In the event that a portion of the changes in fair value were determined to be ineffective, the ineffective amount would be recorded in earnings.

The following tables provide information on derivatives related to variable rate borrowings as of:

March 31, 2017

Pay Rate

Receive Rate

Remaining Life (Years)

Notional Amount

Balance Sheet Location

Fair Value

Derivatives designated as hedging instruments

Cash Flow Hedges:

Interest rate swaps

1.56

3-Month LIBOR

4.1

10,000

Other Assets

265

December 31, 2016

Pay Rate

Receive Rate

Remaining Life (Years)

Notional Amount

Balance Sheet Location

Fair Value

Derivatives designated as hedging instruments

Cash Flow Hedges:

Interest rate swaps

1.56

3-Month LIBOR

4.3

10,000

Other Assets

248

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

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Note 9 – Other Noninterest Expenses

A summary of expenses included in other noninterest expenses is as follows for the:



	Three Months Ended March 31
	2017		2016
Director fees	$	209	$	209
Consulting fees	205		173
Audit and related fees	198		159
FDIC insurance premiums	153		205
Donations and community relations	130		111
Loan underwriting fees	117		108
Postage and freight	109		106
Printing and supplies	107		78
Education and travel	96		111
Marketing costs	89		155
All other	465		587
Total other	$	1,878	$	2,002

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
	2017			2016
Income taxes at 34% statutory rate	$	1,247		$	1,174
Effect of nontaxable income
Interest income on tax exempt municipal securities	(455		)	(478		)
Earnings on corporate owned life insurance policies	(61		)	(64		)
Effect of tax credits	(189		)	(194		)
Other	(18		)	(18		)
Total effect of nontaxable income	(723		)	(754		)
Effect of nondeductible expenses	8			17
Federal income tax expense	$	532		$	437

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Note 11 – Fair Value

Following is a description of the valuation methodologies, key inputs, and an indication of the level of the fair value hierarchy in which the assets or liabilities are classified.

Cash and cash equivalents: The carrying amounts of cash and demand deposits due from banks and interest bearing balances due from banks approximate fair values. As such, we classify cash and cash equivalents as Level 1.

AFS securities: AFS securities are recorded at fair value on a recurring basis. Level 1 fair value measurement is based upon quoted prices for identical instruments. Level 2 fair value measurement is based upon quoted prices for similar instruments. If quoted prices are not available, fair values are measured using independent pricing models or other model based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions. The values for Level 1 and Level 2 investment securities are generally obtained from an independent third party. On a quarterly basis, we compare the values provided to alternative pricing sources.

Mortgage loans AFS: Mortgage loans AFS are carried at the lower of cost or fair value. The fair value of mortgage loans AFS are based on the price secondary markets are currently offering for portfolios with similar characteristics. As such, we classify mortgage loans AFS subject to nonrecurring fair value adjustments as Level 2.

Loans: For variable rate loans with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. As such, we classify loans as Level 3 assets.

We do not record loans at fair value on a recurring basis. However, from time-to-time, loans are classified as impaired and a specific allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will be significantly different than the contractual terms of the original loan agreement are considered impaired. Once a loan is identified as impaired, we measure the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less 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, 2017
Valuation Technique	Fair Value	Unobservable Input	Range
		Discount applied to collateral appraisal:
		Real Estate	20% - 30%
		Equipment	20% - 45%
Discounted appraisal value	$9,693	Cash crop inventory	30% - 40%
		Liquor license	75%
		Furniture, fixtures & equipment	40% - 45%

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	December 31, 2016
Valuation Technique	Fair Value	Unobservable Input	Range
		Discount applied to collateral appraisal:
		Real Estate	20% - 30%
		Equipment	20% - 45%
Discounted appraisal value	$9,166	Cash crop inventory	30% - 40%
		Liquor license	75%
		Furniture, fixtures & equipment	45%

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 minority ownership interest in Corporate Settlement Solutions, LLC. The investment in Corporate Settlement Solutions, LLC, a title insurance agency, was made in the first quarter 2008 and we account for our investment under the equity method of accounting.

The lack of an active market, or other independent sources to validate fair value estimates coupled with the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. As the fair values of these investments are not readily determinable, they are not disclosed under a specific fair value hierarchy; however, they are reviewed quarterly for impairment. If we were to record an impairment adjustment related to these securities, it would be classified as a nonrecurring Level 3 fair value adjustment. During 2017 and 2016, there were no impairments recorded on equity securities without readily determinable fair values.

Foreclosed assets: Upon transfer from the loan portfolio, foreclosed assets (which are included in other assets) are adjusted to and subsequently carried at the lower of carrying value or fair value less costs to sell. Net realizable value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. Due to the inherent level of estimation in the valuation process, we classify foreclosed assets as nonrecurring Level 3.

The table below lists the quantitative fair value information related to foreclosed assets as of:



	March 31, 2017
Valuation Technique	Fair Value		Unobservable Input	Range
			Discount applied to collateral appraisal:
Discounted appraisal value	$	158	Real Estate	20% - 30%



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

Discount factors with ranges are based on the age of the independent appraisal, broker price opinion, or internal evaluations.

Goodwill and other intangible assets: Acquisition intangibles and goodwill are evaluated for potential impairment on at least an annual basis. Acquisition intangibles and goodwill are typically qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired. If it is determined that the carrying balance of acquisition intangibles or goodwill is more likely than not to be impaired, we perform a cash flow valuation to determine the extent of the potential impairment. If the testing resulted in impairment, we would classify goodwill and other acquisition intangibles subjected to nonrecurring fair value adjustments as Level 3. During 2017 and 2016, 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

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value through a valuation allowance as determined by the model. As such, we classify OMSR subject to nonrecurring fair value adjustments as Level 2.

Deposits: The fair value of demand, savings, and money market deposits are equal to their carrying amounts and are classified as Level 1. Fair values for variable rate certificates of deposit approximate their carrying value. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. As such, fixed rate certificates of deposit are classified as Level 2.

Borrowed funds: The carrying amounts of federal funds purchased, borrowings under overnight repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values. The fair values of other borrowed funds are estimated using discounted cash flow analyses based on current incremental borrowing arrangements. As such, borrowed funds are classified as Level 2.

Accrued interest payable: The carrying amounts of accrued interest payable approximate fair value. As such, we classify accrued interest payable as Level 1.

Derivative instruments: Derivative instruments, consisting solely of interest rate swaps, are recorded at fair value on a recurring basis. Derivatives qualifying as cash flow hedges, when highly effective, are reported at fair value in other assets or other liabilities on our Consolidated Balance Sheets with changes in value recorded in OCI. Should the hedge no longer be considered effective, the ineffective portion of the change in fair value is recorded directly in earnings in the period in which the change occurs. The fair value of a derivative is determined by quoted market prices and model based valuation techniques. As such, we classify derivative instruments as Level 2.

Commitments to extend credit, standby letters of credit, and undisbursed loans: Our commitments to extend credit, standby letters of credit, and undisbursed funds have no carrying amount and are estimated to have no realizable fair value. Historically, a majority of the unused commitments to extend credit have not been drawn upon and, generally, we do not receive fees in connection with these commitments other than standby letter of credit fees, which are not significant.

The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Although we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement.

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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, 2017
	Carrying Value		Estimated Fair Value		(Level 1)		(Level 2)		(Level 3)
ASSETS
Cash and cash equivalents	$	18,060	$	18,060	$	18,060	$	—	$	—
Mortgage loans AFS	1,768		1,777		—		1,777		—
Gross loans	1,012,920		992,374		—		—		992,374
Less allowance for loan and lease losses	7,500		7,500		—		—		7,500
Net loans	1,005,420		984,874		—		—		984,874
Accrued interest receivable	7,046		7,046		7,046		—		—
Equity securities without readily determinable fair values (1)	21,616		N/A		—		—		—
OMSR	2,507		2,635		—		2,635		—
LIABILITIES
Deposits without stated maturities	789,710		789,710		789,710		—		—
Deposits with stated maturities	441,351		437,644		—		437,644		—
Borrowed funds	327,375		326,144		—		326,144		—
Accrued interest payable	582		582		582		—		—



	December 31, 2016
	Carrying Value		Estimated Fair Value		(Level 1)		(Level 2)		(Level 3)
ASSETS
Cash and cash equivalents	$	22,894	$	22,894	$	22,894	$	—	$	—
Mortgage loans AFS	1,816		1,836		—		1,836		—
Gross loans	1,010,615		991,009		—		—		991,009
Less allowance for loan and lease losses	7,400		7,400		—		—		7,400
Net loans	1,003,215		983,609		—		—		983,609
Accrued interest receivable	6,580		6,580		6,580		—		—
Equity securities without readily determinable fair values (1)	21,694		N/A		—		—		—
OMSR	2,306		2,306		—		2,306		—
LIABILITIES
Deposits without stated maturities	761,626		761,626		761,626		—		—
Deposits with stated maturities	433,414		430,088		—		430,088		—
Borrowed funds	337,694		336,975		—		336,975		—
Accrued interest payable	574		574		574		—		—


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

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Financial Instruments Recorded at Fair Value

The table below presents the recorded amount of assets and liabilities measured at fair value on:



	March 31, 2017											December 31, 2016
	Total		(Level 1)			(Level 2)			(Level 3)			Total		(Level 1)			(Level 2)			(Level 3)
Recurring items
AFS securities
Government-sponsored enterprises	$	10,264	$	—		$	10,264		$	—		$	10,259	$	—		$	10,259		$	—
States and political subdivisions	222,777		—			222,777			—			212,919		—			212,919			—
Auction rate money market preferred	2,977		—			2,977			—			2,794		—			2,794			—
Preferred stocks	3,597		3,597			—			—			3,425		3,425			—			—
Mortgage-backed securities	229,774		—			229,774			—			227,256		—			227,256			—
Collateralized mortgage obligations	120,725		—			120,725			—			101,443		—			101,443			—
Total AFS securities	590,114		3,597			586,517			—			558,096		3,425			554,671			—
Derivative instruments	265		—			265			—			248		—			248			—
Nonrecurring items
Impaired loans (net of the ALLL)	9,693		—			—			9,693			9,166		—			—			9,166
Foreclosed assets	158		—			—			158			231		—			—			231
Total	$	600,230	$	3,597		$	586,782		$	9,851		$	567,741	$	3,425		$	554,919		$	9,397
Percent of assets and liabilities measured at fair value			0.60		%	97.76		%	1.64		%			0.60		%	97.74		%	1.66		%

We had no assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a recurring basis, as of March 31, 2017. Foreclosed assets, which are recorded at fair value with changes in fair value recognized through earnings on a nonrecurring basis, were written down due to $158 as of March 31, 2017 which resulted in an impairment recorded through earnings in the amount of $28 for the three month period ended March 31, 2017. We had no other assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a nonrecurring basis, as of March 31, 2017.

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Note 12 – Accumulated Other Comprehensive Income

The following table summarizes the changes in AOCI by component for the:



	Three Months Ended March 31
	2017												2016
	Unrealized Holding Gains (Losses) on AFS Securities			Unrealized Gains (Losses) on Derivative Instruments			Defined Benefit Pension Plan			Total			Unrealized Holding Gains (Losses) on AFS Securities			Unrealized Gains (Losses) on Derivative Instruments		Defined Benefit Pension Plan			Total
Balance, January 1	$	30		$	164		$	(2,972	)	$	(2,778	)	$	3,536		$	—	$	(3,315	)	$	221
OCI before reclassifications	1,677			17			—			1,694			7,274			—		—			7,274
Tax effect	(450		)	(6		)	—			(456		)	(2,477		)	—		—			(2,477		)
OCI, net of tax	1,227			11			—			1,238			4,797			—		—			4,797
Balance, March 31	$	1,257		$	175		$	(2,972	)	$	(1,540	)	$	8,333		$	—	$	(3,315	)	$	5,018

Included in OCI for the three month periods ended March 31, 2017 and 2016 are changes in unrealized holding gains and losses related to auction rate money market preferred and preferred stocks. For federal income tax purposes, these securities are considered equity investments. As such, no deferred federal income taxes related to unrealized holding gains or losses are expected or recorded.

A summary of the components of unrealized holding gains on AFS securities included in OCI follows for the:



	Three Months Ended March 31
	2017								2016
	Auction Rate Money Market Preferred and Preferred Stocks		All Other AFS Securities			Total			Auction Rate Money Market Preferred and Preferred Stocks			All Other AFS Securities			Total
Unrealized gains (losses) arising during the period	$	355	$	1,322		$	1,677		$	(12	)	$	7,286		$	7,274
Tax effect	—		(450		)	(450		)	—			(2,477		)	(2,477		)
Unrealized gains (losses), net of tax	$	355	$	872		$	1,227		$	(12	)	$	4,809		$	4,797

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Note 13 – Parent Company Only Financial Information

Interim Condensed Balance Sheets



	March 31 2017		December 31 2016
ASSETS
Cash on deposit at the Bank	$	451	$	1,297
AFS securities	—		251
Investments in subsidiaries	141,837		138,549
Premises and equipment	1,955		1,991
Other assets	52,695		52,846
TOTAL ASSETS	$	196,938	$	194,934
LIABILITIES AND SHAREHOLDERS’ EQUITY
Other liabilities	$	5,962	$	7,035
Shareholders' equity	190,976		187,899
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	196,938	$	194,934

Interim Condensed Statements of Income



	Three Months Ended March 31
	2017		2016
Income
Dividends from subsidiaries	$	1,700	$	1,600
Interest income	2		4
Management fee and other	1,550		1,524
Total income	3,252		3,128
Expenses
Compensation and benefits	1,372		1,200
Occupancy and equipment	444		430
Audit and related fees	124		96
Other	541		546
Total expenses	2,481		2,272
Income before income tax benefit and equity in undistributed earnings of subsidiaries	771		856
Federal income tax benefit	316		246
Income before equity in undistributed earnings of subsidiaries	1,087		1,102
Undistributed earnings of subsidiaries	2,049		1,915
Net income	$	3,136	$	3,017

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Interim Condensed Statements of Cash Flows



	Three Months Ended March 31
	2017			2016
Operating activities
Net income	$	3,136		$	3,017
Adjustments to reconcile net income to cash provided by operations
Undistributed earnings of subsidiaries	(2,049		)	(1,915		)
Undistributed earnings of equity securities without readily determinable fair values	78			61
Share-based payment awards under equity compensation plan	178			158
Depreciation	39			41
Changes in operating assets and liabilities which provided (used) cash
Other assets	74			173
Accrued interest and other liabilities	(1,073		)	(229		)
Net cash provided by (used in) operating activities	383			1,306
Investing activities
Maturities, calls, principal payments, and sales of AFS securities	249			—
Purchases of premises and equipment	(3		)	(45		)
Net cash provided by (used in) investing activities	246			(45		)
Financing activities
Cash dividends paid on common stock	(1,953		)	(1,872		)
Proceeds from the issuance of common stock	1,770			1,072
Common stock repurchased	(1,169		)	(799		)
Common stock purchased for deferred compensation obligations	(123		)	(97		)
Net cash provided by (used in) financing activities	(1,475		)	(1,696		)
Increase (decrease) in cash and cash equivalents	(846		)	(435		)
Cash and cash equivalents at beginning of period	1,297			4,125
Cash and cash equivalents at end of period	$	451		$	3,690

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, 2017 and 2016 and each of the three month periods then ended, represent approximately 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented.

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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, 2017 and 2016. This analysis should be read in conjunction with our 2016 Annual Report on Form 10-K and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 4 of this report.

Executive Summary

During the three months ended March 31, 2017 and 2016, we reported net income of $3,136 and $3,017 and earnings per common share of $0.40 and $0.39, respectively. The increase in earnings was primarily driven by interest income which increased $780 for the first three months of 2017 in comparison to the same period in 2016. Increased interest income is the result of strong loan growth during 2016.

During the three month period ended March 31, 2017, total assets grew by 1.66% to $1,760,860, and assets under management increased to $2,475,826 which includes loans sold and serviced, and assets managed by our Investment and Trust Services Department of $714,966. Total loans increased by $2,305 from December 31, 2016 which was largely driven by growth in the commercial and residential mortgage portfolios. Total AFS securities increased by $32,018 during the first quarter of 2017 which was funded by strong deposit growth of $36,021 during the quarter.

Our net yield on interest earning assets remains historically low at 2.99% for the three months ended March 31, 2017. The growth in net interest income will increase only through continued growth in a strategic mix of loans, investments, and other income earning assets. We do not anticipate that the Federal Reserve Bank will increase short term interest rates significantly in the remainder of 2017; therefore, we do not anticipate significant improvements in our net yield on interest earning assets in the short term. We are committed to increasing earnings and shareholder value through growth in our loan portfolio, growth in our investment and trust services, and increasing our geographical presence while managing operating costs.

Reclassifications: Certain amounts reported in the 2016 consolidated financial statements have been reclassified to conform with the 2017 presentation.

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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 2017			December 31 2016			September 30 2016			June 30 2016			March 31 2016
INCOME STATEMENT DATA
Interest income	$	13,861		$	13,760		$	13,607		$	13,218		$	13,081
Interest expense	2,831			2,826			2,747			2,678			2,614
Net interest income	11,030			10,934			10,860			10,540			10,467
Provision for loan losses	27			(320		)	17			12			156
Noninterest income	2,616			3,187			2,946			2,752			2,223
Noninterest expenses	9,951			10,166			9,433			9,218			9,080
Federal income tax expense	532			493			763			655			437
Net Income	$	3,136		$	3,782		$	3,593		$	3,407		$	3,017
PER SHARE
Basic earnings	$	0.40		$	0.48		$	0.46		$	0.44		$	0.39
Diluted earnings	$	0.39		$	0.47		$	0.45		$	0.43		$	0.38
Dividends	$	0.25		$	0.25		$	0.25		$	0.24		$	0.24
Tangible book value*	$	18.34		$	18.16		$	17.93		$	17.72		$	17.47
Quoted market value
High	$	29.00		$	28.35		$	28.08		$	28.25		$	29.90
Low	$	27.60		$	27.60		$	27.60		$	27.63		$	27.25
Close*	$	27.60		$	27.85		$	27.70		$	27.90		$	28.25
Common shares outstanding*	7,843,120			7,821,069			7,833,481			7,836,442			7,809,079
PERFORMANCE RATIOS
Return on average total assets	0.72		%	0.88		%	0.85		%	0.81		%	0.72		%
Return on average shareholders' equity	6.56		%	7.77		%	7.27		%	7.05		%	6.37		%
Return on average tangible shareholders' equity	8.77		%	10.70		%	10.28		%	9.89		%	8.88		%
Net interest margin yield (FTE)	2.99		%	3.01		%	3.05		%	2.97		%	2.98		%
BALANCE SHEET DATA*
Gross loans	$	1,012,920		$	1,010,615		$	989,366		$	919,594		$	870,291
AFS securities	$	590,114		$	558,096		$	564,229		$	602,463		$	649,859
Total assets	$	1,760,860		$	1,732,151		$	1,706,498		$	1,680,359		$	1,681,818
Deposits	$	1,231,061		$	1,195,040		$	1,175,833		$	1,156,870		$	1,173,507
Borrowed funds	$	327,375		$	337,694		$	325,409		$	318,596		$	307,896
Shareholders' equity	$	190,976		$	187,899		$	195,184		$	195,133		$	190,247
Gross loans to deposits	82.28		%	84.57		%	84.14		%	79.49		%	74.16		%
ASSETS UNDER MANAGEMENT*
Loans sold with servicing retained	$	270,217		$	272,882		$	275,037		$	275,958		$	282,618
Assets managed by our Investment and Trust Services Department	$	444,749		$	427,693		$	424,573		$	415,762		$	408,224
Total assets under management	$	2,475,826		$	2,432,726		$	2,406,108		$	2,372,079		$	2,372,660
ASSET QUALITY*
Nonperforming loans to gross loans	0.24		%	0.17		%	0.16		%	0.13		%	0.12		%
Nonperforming assets to total assets	0.15		%	0.11		%	0.11		%	0.09		%	0.08		%
ALLL to gross loans	0.74		%	0.73		%	0.79		%	0.83		%	0.86		%
CAPITAL RATIOS*
Shareholders' equity to assets	10.85		%	10.85		%	11.44		%	11.61		%	11.31		%
Tier 1 leverage	8.54		%	8.56		%	8.59		%	8.50		%	8.44		%
Common equity tier 1 capital	12.49		%	12.39		%	12.41		%	13.08		%	13.24		%
Tier 1 risk-based capital	12.49		%	12.39		%	12.41		%	13.08		%	13.24		%
Total risk-based capital	13.14		%	13.04		%	13.10		%	13.80		%	13.97		%

* At end of period

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



	March 31 2017			March 31 2016			March 31 2015			March 31 2014			March 31 2013
INCOME STATEMENT DATA
Interest income	$	13,861		$	13,081		$	12,753		$	12,693		$	12,602
Interest expense	2,831			2,614			2,488			2,500			2,821
Net interest income	11,030			10,467			10,265			10,193			9,781
Provision for loan losses	27			156			(726		)	(242		)	300
Noninterest income	2,616			2,223			2,128			2,249			2,447
Noninterest expenses	9,951			9,080			8,675			8,815			8,265
Federal income tax expense	532			437			771			560			576
Net Income	$	3,136		$	3,017		$	3,673		$	3,309		$	3,087
PER SHARE
Basic earnings	$	0.40		$	0.39		$	0.47		$	0.43		$	0.40
Diluted earnings	$	0.39		$	0.38		$	0.46		$	0.42		$	0.39
Dividends	$	0.25		$	0.24		$	0.23		$	0.22		$	0.21
Tangible book value*	$	18.34		$	17.47		$	16.84		$	15.82		$	14.95
Quoted market value
High	$	29.00		$	29.90		$	23.50		$	23.94		$	25.10
Low	$	27.60		$	27.25		$	22.00		$	22.25		$	21.55
Close*	$	27.60		$	28.25		$	22.90		$	23.00		$	25.00
Common shares outstanding*	7,843,120			7,809,079			7,781,820			7,727,547			7,688,928
PERFORMANCE RATIOS
Return on average total assets	0.72		%	0.72		%	0.95		%	0.88		%	0.86		%
Return on average shareholders' equity	6.56		%	6.37		%	8.27		%	8.04		%	7.51		%
Return on average tangible shareholders' equity	8.77		%	8.88		%	11.30		%	10.92		%	10.86		%
Net interest margin yield (FTE)	2.99		%	2.98		%	3.18		%	3.21		%	3.25		%
BALANCE SHEET DATA*
Gross loans	$	1,012,920		$	870,291		$	818,493		$	811,242		$	769,574
AFS securities	$	590,114		$	649,859		$	605,208		$	555,144		$	520,931
Total assets	$	1,760,860		$	1,681,818		$	1,571,575		$	1,513,371		$	1,434,705
Deposits	$	1,231,061		$	1,173,507		$	1,098,655		$	1,065,935		$	1,029,760
Borrowed funds	$	327,375		$	307,896		$	283,321		$	272,536		$	232,410
Shareholders' equity	$	190,976		$	190,247		$	179,653		$	165,971		$	165,308
Gross loans to deposits	82.28		%	74.16		%	74.50		%	76.11		%	74.73		%
ASSETS UNDER MANAGEMENT*
Loans sold with servicing retained	$	270,217		$	282,618		$	288,448		$	292,382		$	301,476
Assets managed by our Investment and Trust Services Department	$	444,749		$	408,224		$	396,802		$	358,811		$	336,632
Total assets under management	$	2,475,826		$	2,372,660		$	2,256,825		$	2,164,564		$	2,072,813
ASSET QUALITY*
Nonperforming loans to gross loans	0.24		%	0.12		%	0.44		%	0.65		%	0.90		%
Nonperforming assets to total assets	0.15		%	0.08		%	0.27		%	0.42		%	0.56		%
ALLL to gross loans	0.74		%	0.86		%	1.17		%	1.37		%	1.55		%
CAPITAL RATIOS*
Shareholders' equity to assets	10.85		%	11.31		%	11.43		%	10.97		%	11.52		%
Tier 1 leverage	8.54		%	8.44		%	8.74		%	8.38		%	8.28		%
Common equity tier 1 capital	12.49		%	13.24		%	13.71		%	N/A			N/A
Tier 1 risk-based capital	12.49		%	13.24		%	13.71		%	13.89		%	13.62		%
Total risk-based capital	13.14		%	13.97		%	14.71		%	15.14		%	14.87		%

* At end of period

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Average Balances, Interest Rate, and Net Interest Income

The following schedules present the daily average amount outstanding for each major category of interest earning assets, non-earning assets, interest bearing liabilities, and noninterest bearing liabilities. These schedules also present an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a FTE basis using a 34% federal income tax rate. Loans in nonaccrual status, for the purpose of the following computations, are included in the average loan balances. FRB and FHLB restricted equity holdings are included in accrued income and other assets.



	Three Months Ended
	March 31, 2017							December 31, 2016							March 31, 2016
	Average Balance			Tax Equivalent Interest		Average Yield / Rate		Average Balance			Tax Equivalent Interest		Average Yield / Rate		Average Balance			Tax Equivalent Interest		Average Yield / Rate
INTEREST EARNING ASSETS
Loans	$	997,443		$	10,120	4.06	%	$	988,779		$	10,217	4.13	%	$	857,784		$	9,038	4.21	%
Taxable investment securities	364,251			2,151		2.36	%	354,352			2,006		2.26	%	432,747			2,400		2.22	%
Nontaxable investment securities	205,372			2,316		4.51	%	198,543			2,260		4.55	%	211,695			2,424		4.58	%
Fed Funds Sold	2,397			4		0.67	%	—			—		—	%	—			—		—	%
Other	26,929			171		2.54	%	26,595			159		2.39	%	26,929			158		2.35	%
Total earning assets	1,596,392			14,762		3.70	%	1,568,269			14,642		3.73	%	1,529,155			14,020		3.67	%
NONEARNING ASSETS
Allowance for loan losses	(7,480		)					(7,820		)					(7,439		)
Cash and demand deposits due from banks	18,736							18,324							17,769
Premises and equipment	29,238							29,197							28,253
Accrued income and other assets	97,692							101,771							100,770
Total assets	$	1,734,578						$	1,709,741						$	1,668,508
INTEREST BEARING LIABILITIES
Interest bearing demand deposits	$	213,617		53		0.10	%	$	196,513		40		0.08	%	$	208,309		42		0.08	%
Savings deposits	354,006			222		0.25	%	333,875			197		0.24	%	342,540			144		0.17	%
Time deposits	436,003			1,265		1.16	%	436,553			1,286		1.18	%	420,913			1,213		1.15	%
Borrowed funds	328,368			1,291		1.57	%	330,927			1,303		1.57	%	310,637			1,215		1.56	%
Total interest bearing liabilities	1,331,994			2,831		0.85	%	1,297,868			2,826		0.87	%	1,282,399			2,614		0.82	%
NONINTEREST BEARING LIABILITIES
Demand deposits	200,598							206,245							187,067
Other	10,841							11,002							9,592
Shareholders’ equity	191,145							194,626							189,450
Total liabilities and shareholders’ equity	$	1,734,578						$	1,709,741						$	1,668,508
Net interest income (FTE)				$	11,931						$	11,816						$	11,406
Net yield on interest earning assets (FTE)						2.99	%						3.01	%						2.98	%

Net Interest Income

Net interest income is the amount by which interest income on earning assets exceeds the interest expenses on interest bearing liabilities. Net interest income, which includes loan fees, is influenced by changes in the balance and mix of assets and liabilities and market interest rates. We exert some control over these factors; however, FRB monetary policy and competition have a significant impact. For analytical purposes, net interest income is adjusted to an FTE basis by adding the income tax

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savings from interest on tax exempt loans, and nontaxable investment securities, thus making year to year comparisons more meaningful.

Volume and Rate Variance Analysis

The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. For the purpose of this table, changes in interest due to volume and rate were determined as follows:

Volume—change in volume multiplied by the previous period's rate.

Rate—change in the FTE rate multiplied by the previous period's volume.

The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.



	Three Months Ended March 31, 2017 Compared to December 31, 2016 Increase (Decrease) Due to									Three Months Ended March 31, 2017 Compared to March 31, 2016 Increase (Decrease) Due to
	Volume			Rate			Net			Volume			Rate			Net
Changes in interest income
Loans	$	89		$	(186	)	$	(97	)	$	1,427		$	(345	)	$	1,082
Taxable investment securities	57			88			145			(397		)	148			(249		)
Nontaxable investment securities	77			(21		)	56			(72		)	(36		)	(108		)
Fed Funds Sold	4			—			4			4			—			4
Other	2			10			12			—			13			13
Total changes in interest income	229			(109		)	120			962			(220		)	742
Changes in interest expense
Interest bearing demand deposits	4			9			13			1			10			11
Savings deposits	12			13			25			5			73			78
Time deposits	(2		)	(19		)	(21		)	44			8			52
Borrowed funds	(10		)	(2		)	(12		)	70			6			76
Total changes in interest expense	4			1			5			120			97			217
Net change in interest margin (FTE)	$	225		$	(110	)	$	115		$	842		$	(317	)	$	525

Our net yield on interest earning assets remains at historically low levels. The persistent low interest rate environment coupled with a high concentration of AFS securities as a percentage of earning assets has also placed downward pressure on net interest margin. While we do not anticipate significant improvement in our net yield on interest earning assets, we do expect marginal improvement as a result of loan growth throughout 2017.



	Average Yield / Rate for the Three Month Periods Ended:
	March 31 2017		December 31 2016		September 30 2016		June 30 2016		March 31 2016
Total earning assets	3.70	%	3.73	%	3.76	%	3.66	%	3.67	%
Total interest bearing liabilities	0.85	%	0.87	%	0.86	%	0.83	%	0.82	%
Net yield on interest earning assets (FTE)	2.99	%	3.01	%	3.05	%	2.97	%	2.98	%



	Quarter to Date Net Interest Income (FTE)
	March 31 2017		December 31 2016		September 30 2016		June 30 2016		March 31 2016
Total interest income (FTE)	$	14,762	$	14,642	$	14,508	$	14,132	$	14,020
Total interest expense	2,831		2,826		2,747		2,678		2,614
Net interest income (FTE)	$	11,931	$	11,816	$	11,761	$	11,454	$	11,406

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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 Months Ended March 31
	2017			2016			Variance
ALLL at beginning of period	$	7,400		$	7,400		$	—
Charge-offs
Commercial and agricultural	27			16			11
Residential real estate	43			241			(198		)
Consumer	74			84			(10		)
Total charge-offs	144			341			(197		)
Recoveries
Commercial and agricultural	133			181			(48		)
Residential real estate	36			50			(14		)
Consumer	48			54			(6		)
Total recoveries	217			285			(68		)
Net loan charge-offs	(73		)	56			(129		)
Provision for loan losses	27			156			(129		)
ALLL at end of period	$	7,500		$	7,500		$	—
Net loan charge-offs to average loans outstanding	(0.01		)%	0.01		%	(0.02		)%

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



	March 31 2017			December 31 2016			September 30 2016			June 30 2016			March 31 2016
Total charge-offs	$	144		$	236		$	131		$	208		$	341
Total recoveries	217			156			314			296			285
Net loan charge-offs	(73		)	80			(183		)	(88		)	56
Net loan charge-offs to average loans outstanding	(0.01		)%	0.01		%	(0.02		)%	(0.01		)%	0.01		%
Provision for loan losses	$	27		$	(320	)	$	17		$	12		$	156
Provision for loan losses to average loans outstanding	—		%	(0.03		)%	—		%	—		%	0.02		%
ALLL	$	7,500		$	7,400		$	7,800		$	7,600		$	7,500
ALLL as a % of loans at end of period	0.74		%	0.73		%	0.79		%	0.83		%	0.86		%

Net loan recoveries and improvement in credit quality indicators have resulted in a reduction of the ALLL as a percentage of loans over the past year. During this time, credit quality indicators, specifically historical loss factors, remain strong and have led to lower levels of required reserves. While they can be more volatile, loans individually evaluated for impairment have been steadily declining. The addition of advances to mortgage brokers contributed to the overall decline in the level of ALLL to gross loans as there are no historical losses requiring reserves. While these advances contribute to other qualitative factors, the impact is not significant on the required level of the ALLL.

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



	March 31 2017			December 31 2016			September 30 2016			June 30 2016			March 31 2016
ALLL
Individually evaluated for impairment	$	2,381		$	2,371		$	2,523		$	2,602		$	2,731
Collectively evaluated for impairment	5,119			5,029			5,277			4,998			4,769
Total	$	7,500		$	7,400		$	7,800		$	7,600		$	7,500
ALLL to gross loans
Individually evaluated for impairment	0.24		%	0.23		%	0.26		%	0.28		%	0.31		%
Collectively evaluated for impairment	0.50		%	0.50		%	0.53		%	0.55		%	0.55		%
Total	0.74		%	0.73		%	0.79		%	0.83		%	0.86		%

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 2017			December 31 2016			September 30 2016			June 30 2016			March 31 2016
Commercial and agricultural	$	5,758		$	4,598		$	3,148		$	2,247		$	2,167
Residential real estate	3,168			2,716			2,436			2,755			2,847
Consumer	35			115			51			23			28
Total	$	8,961		$	7,429		$	5,635		$	5,025		$	5,042
Total past due and nonaccrual loans to gross loans	0.88		%	0.74		%	0.57		%	0.55		%	0.58		%

While past due and nonaccrual status loans have increased over the last year, they continue to be below historical norms and are the result of improved loan performance. A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual status loans by type, is included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

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Troubled Debt Restructurings

We have taken a proactive approach to avoid foreclosures on borrowers who are willing to work with us in modifying their loans, thus making them more affordable. While this approach has permitted certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure, it has contributed to a significant level of loans classified as TDR. The modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. At the time of the TDR, the loan is reviewed to determine whether or not to classify the loan as accrual or nonaccrual status. The majority of new modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed on nonaccrual status may be placed back on accrual status after six months of continued performance.

We restructure debt with borrowers who, due to financial difficulties, are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, 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, 2017 or December 31, 2016.

Losses associated with TDRs, if any, are included in the estimation of the ALLL in the quarter in which a loan is identified as a TDR, and we review the analysis of the ALLL estimation each reporting period to ensure its continued appropriateness.

The following tables provide a roll-forward of TDRs for the:



	Three Months Ended March 31, 2017
	Accruing Interest					Nonaccrual					Total
	Number of Loans		Balance			Number of Loans		Balance			Number of Loans		Balance
January 1, 2017	153		$	20,593		5		$	789		158		$	21,382
New modifications	3		235			—		—			3		235
Principal advances (payments)	—		(309		)	—		(6		)	—		(315		)
Loans paid-off	(5	)	(251		)	—		—			(5	)	(251		)
Partial charge-offs	—		—			—		—			—		—
Balances charged-off	—		—			—		—			—		—
Transfers to OREO	—		—			—		—			—		—
Transfers to accrual status	1		75			(1	)	(75		)	—		—
Transfers to nonaccrual status	(2	)	(92		)	2		92			—		—
March 31, 2017	150		$	20,251		6		$	800		156		$	21,051



	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

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The following table summarizes our TDRs as of:



	March 31, 2017						December 31, 2016
	Accruing Interest		Nonaccrual		Total		Accruing Interest		Nonaccrual		Total		Total Change
Current	$	17,239	$	53	$	17,292	$	17,557	$	559	$	18,116	$	(824	)
Past due 30-59 days	2,789		301		3,090		2,898		230		3,128		(38		)
Past due 60-89 days	223		405		628		138		—		138		490
Past due 90 days or more	—		41		41		—		—		—		41
Total	$	20,251	$	800	$	21,051	$	20,593	$	789	$	21,382	$	(331	)

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

Impaired Loans

The following is a summary of information pertaining to impaired loans as of:



	March 31, 2017						December 31, 2016
	Outstanding Balance		Unpaid Principal Balance		Valuation Allowance		Outstanding Balance		Unpaid Principal Balance		Valuation Allowance
TDRs
Commercial real estate	$	6,121	$	6,240	$	676	$	6,264	$	6,383	$	713
Commercial other	1,334		1,334		21		1,444		1,455		25
Agricultural real estate	4,047		4,047		—		4,037		4,037		—
Agricultural other	1,374		1,374		—		1,380		1,380		1
Residential real estate senior liens	7,978		8,357		1,590		8,058		8,437		1,539
Residential real estate junior liens	78		78		16		71		71		13
Home equity lines of credit	96		396		—		102		402		—
Consumer secured	23		23		—		26		26		—
Total TDRs	21,051		21,849		2,303		21,382		22,191		2,291
Other impaired loans
Commercial real estate	146		222		—		151		226		3
Commercial other	—		—		—		—		—		—
Agricultural real estate	—		—		—		—		—		—
Agricultural other	128		128		—		128		128		—
Residential real estate senior liens	398		603		78		406		612		76
Residential real estate junior liens	—		—		—		1		11		1
Home equity lines of credit	67		67		—		—		—		—
Consumer secured	—		—		—		—		—		—
Total other impaired loans	739		1,020		78		686		977		80
Total impaired loans	$	21,790	$	22,869	$	2,381	$	22,068	$	23,168	$	2,371

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

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Nonperforming Assets

The following table summarizes our nonperforming assets as of:



	March 31 2017			December 31 2016			September 30 2016			June 30 2016			March 31 2016
Nonaccrual status loans	$	1,138		$	1,060		$	690		$	974		$	1,016
Accruing loans past due 90 days or more	1,339			633			847			208			55
Total nonperforming loans	2,477			1,693			1,537			1,182			1,071
Foreclosed assets	158			231			284			249			276
Total nonperforming assets	$	2,635		$	1,924		$	1,821		$	1,431		$	1,347
Nonperforming loans as a % of total loans	0.24		%	0.17		%	0.16		%	0.13		%	0.12		%
Nonperforming assets as a % of total assets	0.15		%	0.11		%	0.11		%	0.09		%	0.08		%

Typically after a loan is 90 days past due, it is placed on nonaccrual status unless it is well secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Loans may be placed back on accrual status after six months of continued performance. While nonperforming loans have increased in recent periods, current levels of nonperforming loans continue to reflect historically low levels.

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



	March 31 2017		December 31 2016
Commercial and agricultural	$	405	$	405
Residential real estate	395		384
Total	$	800	$	789

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

We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recording of a charge-off. We believe that we have identified all impaired loans as of March 31, 2017.

We believe that the level of the ALLL is appropriate as of March 31, 2017. We will continue to closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at the appropriate level.

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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
	2017		2016			$			%
Service charges and fees
ATM and debit card fees	$	603	$	597		$	6		1.01	%
NSF and overdraft fees	441		418			23			5.50	%
Freddie Mac servicing fee	169		183			(14		)	(7.65	)%
Service charges on deposit accounts	85		85			—			—	%
Net OMSR income (loss)	201		(102		)	303			N/M
All other	31		32			(1		)	(3.13	)%
Total service charges and fees	1,530		1,213			317			26.13	%
Net gain on sale of mortgage loans	155		82			73			89.02	%
Earnings on corporate owned life insurance policies	180		188			(8		)	(4.26	)%
Other
Trust and brokerage advisory fees	571		526			45			8.56	%
Other	180		214			(34		)	(15.89	)%
Total other	751		740			11			1.49	%
Total noninterest income	$	2,616	$	2,223		$	393		17.68	%

Significant changes in noninterest income are detailed below:


•	Offering rates on residential mortgage loans and prepayment speeds have been the most significant drivers behind fluctuations in net OMSR income (loss). We anticipate increases in mortgage rates and decreased prepayment speeds; therefore, we anticipate net OMSR income to remain positive during the remainder of 2017.


•	We anticipate increases in our originations in purchase money mortgage activity as a result of our various initiatives to drive growth. As a result, we expect net gains on the sale of mortgage loans to increase during 2017.


•	We continue to invest considerable efforts to increase our market share in trust and brokerage advisory services. These efforts have translated into increases in trust fees and brokerage and advisory fees. We anticipate that these fees will continue to increase during the remainder of 2017.


•	The fluctuations in all other income is spread throughout various categories, none of which are individually significant.

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



	Three Months Ended March 31
					Change
	2017		2016		$			%
Compensation and benefits
Employee salaries	$	4,161	$	3,396	$	765		22.53	%
Employee benefits	1,515		1,392		123			8.84	%
Total compensation and benefits	5,676		4,788		888			18.55	%
Furniture and equipment
Service contracts	788		720		68			9.44	%
Depreciation	512		533		(21		)	(3.94	)%
ATM and debit card fees	216		189		27			14.29	%
All other	44		38		6			15.79	%
Total furniture and equipment	1,560		1,480		80			5.41	%
Occupancy
Depreciation	210		194		16			8.25	%
Outside services	199		193		6			3.11	%
Property taxes	146		145		1			0.69	%
Utilities	143		141		2			1.42	%
All other	139		137		2			1.46	%
Total occupancy	837		810		27			3.33	%
Other
Director fees	209		209		—			—	%
Consulting fees	205		173		32			18.50	%
Audit and related fees	198		159		39			24.53	%
FDIC insurance premiums	153		205		(52		)	(25.37	)%
Donations and community relations	130		111		19			17.12	%
Loan underwriting fees	117		108		9			8.33	%
Postage and freight	109		106		3			2.83	%
Printing and supplies	107		78		29			37.18	%
Education and travel	96		111		(15		)	(13.51	)%
Marketing costs	89		155		(66		)	(42.58	)%
All other	465		587		(122		)	(20.78	)%
Total other	1,878		2,002		(124		)	(6.19	)%
Total noninterest expenses	$	9,951	$	9,080	$	871		9.59	%

Significant changes in noninterest expenses are detailed below:


•	Employee salaries have increased in 2017 as a result of new positions required for future growth within our new markets, normal merit increases and increased incentive compensation. As such, we anticipate employee salaries expense to continue to trend higher than expense levels during 2016.


•	FDIC insurance premiums have declined in 2017 as a result of changes to the premium calculation; therefore, 2017 expenses are expected to be lower than 2016.


•	Marketing costs fluctuate from period-to-period based on the timing of campaigns. For the remainder of 2017, expenses are expected to slightly exceed 2016 levels as a result of marketing initiatives planned for 2017.


•	The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.

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Analysis of Changes in Financial Condition



	March 31 2017		December 31 2016		$ Change			% Change (unannualized)
ASSETS
Cash and cash equivalents	$	18,060	$	22,894	$	(4,834	)	(21.11	)%
AFS securities
Amortized cost of AFS securities	587,989		557,648		30,341			5.44	%
Unrealized gains (losses) on AFS securities	2,125		448		1,677			N/M
AFS securities	590,114		558,096		32,018			5.74	%
Mortgage loans AFS	1,768		1,816		(48		)	(2.64	)%
Loans
Gross loans	1,012,920		1,010,615		2,305			0.23	%
Less allowance for loan and lease losses	7,500		7,400		100			1.35	%
Net loans	1,005,420		1,003,215		2,205			0.22	%
Premises and equipment	28,982		29,314		(332		)	(1.13	)%
Corporate owned life insurance policies	26,480		26,300		180			0.68	%
Accrued interest receivable	7,046		6,580		466			7.08	%
Equity securities without readily determinable fair values	21,616		21,694		(78		)	(0.36	)%
Goodwill and other intangible assets	48,635		48,666		(31		)	(0.06	)%
Other assets	12,739		13,576		(837		)	(6.17	)%
TOTAL ASSETS	$	1,760,860	$	1,732,151	$	28,709		1.66	%
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits	$	1,231,061	$	1,195,040	$	36,021		3.01	%
Borrowed funds	327,375		337,694		(10,319		)	(3.06	)%
Accrued interest payable and other liabilities	11,448		11,518		(70		)	(0.61	)%
Total liabilities	1,569,884		1,544,252		25,632			1.66	%
Shareholders’ equity	190,976		187,899		3,077			1.64	%
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,760,860	$	1,732,151	$	28,709		1.66	%

As shown above, total assets have increased $28,709 since December 31, 2016 which was primarily driven by AFS securities growth of $32,018. This growth was funded by an increase in deposits which increased by $36,021 during the first quarter of 2017. While generating quality loans will continue to be competitive, we expect that loans will continue to grow in 2017.

The following table outlines the changes in loans:



	March 31 2017		December 31 2016		$ Change			% Change (unannualized)
Commercial	$	576,822	$	575,664	$	1,158		0.20	%
Agricultural	126,049		126,492		(443		)	(0.35	)%
Residential real estate	267,141		266,050		1,091			0.41	%
Consumer	42,908		42,409		499			1.18	%
Total	$	1,012,920	$	1,010,615	$	2,305		0.23	%

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The following table displays loan balances as of:



	March 31 2017		December 31 2016		September 30 2016		June 30 2016		March 31 2016
Commercial	$	576,822	$	575,664	$	554,847	$	500,374	$	470,305
Agricultural	126,049		126,492		133,637		126,517		115,686
Residential real estate	267,141		266,050		260,122		255,116		249,318
Consumer	42,908		42,409		40,760		37,587		34,982
Total	$	1,012,920	$	1,010,615	$	989,366	$	919,594	$	870,291

While competition for commercial and agricultural loans continues to be strong, we experienced growth in these segments of the portfolio during 2016 and anticipate continued growth in 2017. Residential real estate and consumer loans have experienced growth over the last year and are both expected to increase during 2017.

The following table outlines the changes in deposits:



	March 31 2017		December 31 2016		$ Change			% Change (unannualized)
Noninterest bearing demand deposits	$	207,448	$	205,071	$	2,377		1.16	%
Interest bearing demand deposits	216,975		209,325		7,650			3.65	%
Savings deposits	365,287		347,230		18,057			5.20	%
Certificates of deposit	320,345		321,914		(1,569		)	(0.49	)%
Brokered certificates of deposit	98,442		88,632		9,810			11.07	%
Internet certificates of deposit	22,564		22,868		(304		)	(1.33	)%
Total	$	1,231,061	$	1,195,040	$	36,021		3.01	%

The following table displays deposit balances as of:



	March 31 2017		December 31 2016		September 30 2016		June 30 2016		March 31 2016
Noninterest bearing demand deposits	$	207,448	$	205,071	$	201,804	$	192,194	$	183,820
Interest bearing demand deposits	216,975		209,325		205,817		197,590		215,327
Savings deposits	365,287		347,230		331,414		331,144		352,115
Certificates of deposit	320,345		321,914		324,910		328,771		323,350
Brokered certificates of deposit	98,442		88,632		87,583		83,677		76,014
Internet certificates of deposit	22,564		22,868		24,305		23,494		22,881
Total	$	1,231,061	$	1,195,040	$	1,175,833	$	1,156,870	$	1,173,507

Deposit demand continues to be driven by non-contractual deposits, such as demand and savings deposits, while certificates of

deposit and Internet certificates of deposit have gradually declined. Brokered certificates of deposit offer another source of funding and fluctuate from period-to-period based on our funding needs, including changes in assets such as loans and investments.

Our strong loan growth in 2016, coupled with softer deposit growth, led to sales of AFS securities and a decline in purchases during the year. During the first quarter of 2017, deposit growth outpaced loan demand and we increased our AFS security purchases in response. We remain active in investments with our local schools and municipalities. Future growth is anticipated in state and political subdivisions AFS securities and purchases of mortgage-backed securities and collateralized mortgage

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



	March 31 2017		December 31 2016		September 30 2016		June 30 2016		March 31 2016
Government sponsored enterprises	$	10,264	$	10,259	$	344	$	10,371	$	24,428
States and political subdivisions	222,777		212,919		219,689		226,047		231,472
Auction rate money market preferred	2,977		2,794		3,145		3,119		2,807
Preferred stocks	3,597		3,425		3,588		3,406		3,346
Mortgage-backed securities	229,774		227,256		226,649		240,195		258,284
Collateralized mortgage obligations	120,725		101,443		110,814		119,325		129,522
Total	$	590,114	$	558,096	$	564,229	$	602,463	$	649,859

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



	March 31 2017		December 31 2016		September 30 2016		June 30 2016		March 31 2016
FHLB advances	$	270,000	$	270,000	$	250,000	$	265,000	$	245,000
Securities sold under agreements to repurchase without stated maturity dates	57,375		60,894		54,809		53,596		58,096
Federal funds purchased	—		6,800		20,600		—		4,800
Total	$	327,375	$	337,694	$	325,409	$	318,596	$	307,896

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 63,866 shares or $1,770 of common stock during the first three months of 2017, as compared to 37,465 shares or $1,072 of common stock during the same period in 2016. We also offer the Directors Plan in which participants either directly purchase stock or purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $178 and $158 during the three month periods ended March 31, 2017 and 2016, respectively.

We have a publicly announced common stock repurchase plan. Pursuant to this plan, we repurchased 41,815 shares or $1,169 of common stock during the first three months of 2017 and 28,253 shares or $799 during the first three months of 2016. As of March 31, 2017, we were authorized to repurchase up to an additional 158,142 shares of common stock.

The FRB has established minimum risk based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital. On July 2, 2013, the FRB published revised BASEL III Capital standards for banks. The final rules redefine what is included or deducted from equity capital, changes risk weighting for certain on and off-balance sheet assets, increases the minimum required equity capital to be considered well capitalized, and introduces a capital conservation buffer. The rules, which are being gradually phased in between 2015 and 2019, are not expected to have a material impact on the Corporation but will require us to hold more capital than 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 6.625%. Our primary capital to adjusted average assets, or tier 1 leverage ratio, was 8.54% as of March 31, 2017.

Effective January 1, 2015, the minimum standard for primary, or Tier 1, capital increased from 4.00% to 6.625%. The minimum standard for total capital is 8.625%. Also effective January 1, 2015 was the new common equity tier 1 capital ratio which had a minimum requirement of 4.50%. Beginning on January 1, 2016 the capital conservation buffer went into effect which further increased the required levels. The following table sets forth the percentages required under the Risk Based

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Capital guidelines and our ratios as of:



	March 31 2017		December 31 2016		Minimum Required
Common equity tier 1 capital	12.490	%	12.390	%	5.125	%

Tier 1 capital	12.490	%	12.390	%	6.625	%
Tier 2 capital	0.650	%	0.650	%	2.000	%
Total Capital	13.140	%	13.040	%	8.625	%

Tier 2 capital, or secondary capital, includes only the ALLL. The percentage for the secondary capital under the required column is the maximum amount allowed from all sources.

The FRB and FDIC also prescribe minimum capital requirements for Isabella Bank. At March 31, 2017, the Bank exceeded these minimum capital requirements.

Contractual Obligations and Loan Commitments

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

The following table summarizes our credit related financial instruments with off-balance-sheet risk as of:



	March 31 2017		December 31 2016
Unfunded commitments under lines of credit	$	177,534	$	168,840
Commitments to grant loans	31,240		29,339
Commercial and standby letters of credit	1,326		1,223
Total	$	210,100	$	199,402

Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. These commitments may expire without being drawn upon and do not necessarily represent future cash requirements. Advances to mortgage brokers are also included in unfunded commitments under lines of credit. The unfunded commitment amount is the difference between our outstanding balances and the maximum outstanding aggregate amount.

Commitments to grant loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The amount of collateral obtained, if it is deemed necessary, is based on management’s credit evaluation of the customer. Commitments to grant loans include residential mortgage loans with the majority being loans committed to be sold to the secondary market.

Commercial and standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements, including commercial paper, bond financing, and similar transactions. These commitments to extend credit and letters of credit generally mature within one year. The credit risk involved in these transactions is essentially the same as that involved in extending loans to customers. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon the extension of credit, is based on a credit evaluation of the borrower. While we consider standby letters of credit to be guarantees, the amount of the liability related to such guarantees on the commitment date is not significant and a liability related to such guarantees is not recorded on the consolidated balance sheets.

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.

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Fair Value

We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. AFS securities, cash flow hedge derivative instruments and certain liabilities are recorded at fair value on a recurring basis. Additionally, from time-to-time, we may be required to record at fair value other assets on a nonrecurring basis, such as mortgage loans AFS, impaired loans, goodwill, foreclosed assets, OMSR, and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets.

For further information regarding fair value measurements see “Note 11 – Fair Value” of our notes to the interim condensed consolidated financial statements.

Liquidity

Liquidity is monitored regularly by our Market Risk Committee, which consists of members of senior management. The committee reviews projected cash flows, key ratios, and liquidity available from both primary and secondary sources.

Our primary sources of liquidity are cash and cash equivalents and unencumbered AFS securities. These categories totaled $608,174 or 34.54% of assets as of March 31, 2017 as compared to $580,990 or 33.54% as of December 31, 2016. The increase in primary liquidity is a direct result of our AFS securities purchases during 2017. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Liquidity varies significantly daily, based on customer activity.

Our primary source of funds is through deposit accounts. We also have the ability to borrow from the FHLB, the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As of March 31, 2017, we had available lines of credit of $99,763.

The following table summarizes our sources and uses of cash for the three month period ended March 31:



	2017			2016			$ Variance
Net cash provided by (used in) operating activities	$	4,387		$	4,675		$	(288	)
Net cash provided by (used in) investing activities	(33,448		)	(3,529		)	(29,919		)
Net cash provided by (used in) financing activities	24,227			5,412			18,815
Increase (decrease) in cash and cash equivalents	(4,834		)	6,558			(11,392		)
Cash and cash equivalents January 1	22,894			21,569			1,325
Cash and cash equivalents March 31	$	18,060		$	28,127		$	(10,067	)

Market Risk

Our primary market risks are interest rate risk and liquidity risk. We have no significant foreign exchange risk in the management of IRR. Any changes in foreign exchange rates or commodity prices would have an insignificant impact on our interest income and cash flows.

IRR is the exposure of our net interest income to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. IRR is the fundamental method by which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to our earnings and capital.

The FRB has adopted a policy requiring us to effectively manage the various risks that can have a material impact on our safety and soundness. The risks include credit, interest rate, liquidity, operational, and reputational. We have policies, procedures, and internal controls for measuring and managing these risks. Specifically, our Funds Management policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long term assets, limiting the mismatch in repricing opportunity of assets and liabilities, and the frequency of measuring and reporting to our Board.

The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield

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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, 2017, we projected the change in net interest income during the next 12 and 24 months assuming market interest rates were to immediately decrease by 100 basis points and increase by 100, 200, 300, and 400 basis points in a parallel fashion over the entire yield curve during the same time period. We did not project scenarios showing decreases in interest rates beyond 100 basis points as this is considered extremely unlikely given current interest rate levels. These projections were based on our assets and liabilities remaining static over the next 12 and 24 months, while factoring in probable calls and prepayments of certain investment securities and residential real estate and consumer loans. While it is extremely unlikely that interest rates would immediately increase to these levels, we feel that these extreme scenarios help us identify potential gaps and mismatches in the repricing characteristics of assets and liabilities. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits. As of March 31, 2017, our interest rate sensitivity results were within Board approved limits.

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



	March 31, 2017
	12 Months										24 Months
Immediate basis point change assumption (short-term)	-100		+100		+200		+300		+400		-100		+100		+200		+300		+400
Percent change in net interest income vs. constant rates	(2.49	)%	1.95	%	3.69	%	4.72	%	6.07	%	(2.56	)%	2.41	%	4.28	%	5.11	%	5.79	%



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

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



	March 31, 2017
	2018			2019			2020			2021			2022			Thereafter			Total			Fair Value
Rate sensitive assets
Other interest bearing assets	$	435		$	—		$	100		$	—		$	—		$	—		$	535		$	531
Average interest rates	0.37		%	—		%	0.35		%	—		%	—		%	—		%	0.37		%
AFS securities	$	107,041		$	71,100		$	68,865		$	69,232		$	73,322		$	200,554		$	590,114		$	590,114
Average interest rates	2.41		%	2.44		%	2.53		%	2.65		%	2.53		%	2.56		%	2.52		%
Fixed interest rate loans (1)	$	154,971		$	111,597		$	110,050		$	108,876		$	114,863		$	201,731		$	802,088		$	781,542
Average interest rates	4.11		%	4.30		%	4.30		%	4.22		%	4.19		%	4.05		%	4.17		%
Variable interest rate loans (1)	$	72,540		$	27,495		$	32,871		$	14,902		$	24,210		$	38,814		$	210,832		$	210,832
Average interest rates	4.74		%	4.47		%	4.31		%	3.94		%	3.98		%	3.90		%	4.34		%
Rate sensitive liabilities
Fixed rate borrowed funds	$	137,375		$	60,000		$	30,000		$	10,000		$	60,000		$	20,000		$	317,375		$	316,144
Average interest rates	1.07		%	2.01		%	1.64		%	1.98		%	1.93		%	2.54		%	1.58		%
Variable rate borrowed funds	$	—		$	—		$	—		$	—		$	10,000		$	—		$	10,000		$	10,000
Average interest rates	—		%	—		%	—		%	—		%	1.34		%	—		%	1.34		%
Savings and NOW accounts	$	87,764		$	44,443		$	39,875		$	35,809		$	32,192		$	342,179		$	582,262		$	582,262
Average interest rates	0.58		%	0.13		%	0.13		%	0.13		%	0.13		%	0.13		%	0.20		%
Fixed interest rate certificates of deposit	$	190,245		$	93,641		$	41,431		$	33,691		$	54,532		$	23,971		$	437,511		$	433,804
Average interest rates	0.83		%	1.21		%	1.40		%	1.61		%	1.73		%	1.89		%	1.19		%
Variable interest rate certificates of deposit	$	2,131		$	1,709		$	—		$	—		$	—		$	—		$	3,840		$	3,840
Average interest rates	0.95		%	1.11		%	—		%	—		%	—		%	—		%	1.02		%

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	December 31, 2016
	2017			2018			2019			2020			2021			Thereafter			Total			Fair Value
Rate sensitive assets
Other interest bearing assets	$	2,727		$	—		$	—		$	—		$	—		$	—		$	2,727		$	2,727
Average interest rates	0.34		%	—		%	—		%	—		%	—		%	—		%	0.34		%
AFS securities	$	114,247		$	71,220		$	64,931		$	63,150		$	66,976		$	177,572		$	558,096		$	558,096
Average interest rates	2.35		%	2.38		%	2.45		%	2.64		%	2.57		%	2.50		%	2.47		%
Fixed interest rate loans (1)	$	159,964		$	115,741		$	103,514		$	107,185		$	112,811		$	199,160		$	798,375		$	778,769
Average interest rates	4.15		%	4.25		%	4.34		%	4.16		%	4.15		%	4.10		%	4.18		%
Variable interest rate loans (1)	$	69,024		$	29,179		$	38,248		$	16,179		$	23,632		$	35,978		$	212,240		$	212,240
Average interest rates	4.83		%	4.32		%	4.16		%	3.62		%	3.74		%	3.86		%	4.26		%
Rate sensitive liabilities
Fixed rate borrowed funds	$	137,694		$	50,000		$	60,000		$	10,000		$	50,000		$	20,000		$	327,694		$	326,975
Average interest rates	0.83		%	2.16		%	1.99		%	1.98		%	1.91		%	2.54		%	1.55		%
Variable rate borrowed funds	$	—		$	—		$	—		$	—		$	10,000		$	—		$	10,000		$	10,000
Average interest rates	—		%	—		%	—		%	—		%	1.21		%	—		%	1.21		%
Savings and NOW accounts	$	84,972		$	42,596		$	38,220		$	34,326		$	30,858		$	325,583		$	556,555		$	556,555
Average interest rates	0.57		%	0.12		%	0.11		%	0.11		%	0.11		%	0.11		%	0.18		%
Fixed interest rate certificates of deposit	$	195,389		$	80,139		$	45,110		$	33,929		$	50,978		$	24,881		$	430,426		$	427,100
Average interest rates	0.86		%	1.18		%	1.35		%	1.58		%	1.68		%	1.84		%	1.18		%
Variable interest rate certificates of deposit	$	1,078		$	1,910		$	—		$	—		$	—		$	—		$	2,988		$	2,988
Average interest rates	0.62		%	0.99		%	—		%	—		%	—		%	—		%	0.85		%

⁽¹⁾ The fair value reported is exclusive of the allocation of the ALLL.

We do not believe that there has been a material change in the nature or categories of our primary market risk exposure, or the particular markets that present the primary risk of loss. As of the date of this report, we do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term and we do not expect to make material changes in those methods in the near term. We may change those methods in the future to adapt to changes in circumstances or to implement new techniques.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

The information presented in the section captioned “Market Risk” in Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.

Item 4. Controls and Procedures.

DISCLOSURE CONTROLS AND PROCEDURES

We carried out an evaluation, under the supervision and with the participation of the Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15(d)-15(e) under the Exchange Act) as of March 31, 2017, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as of March 31, 2017, were effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

During the most recent fiscal quarter, no change occurred in our internal control over financial reporting that materially affected, or is likely to materially effect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

We are not involved in any material legal proceedings. We are involved in ordinary, routine litigation incidental to our business; however, no such routine proceedings are expected to result in any material adverse effect on operations, earnings, financial condition, or cash flows.

Item 1A. Risk Factors.

There have been no material changes to the risk factors disclosed in Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2016.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.


(A)	None


(B)	None


(C)	Repurchases of Common Stock

We have adopted and publicly announced a common stock repurchase plan. The plan was last amended on December 21, 2016, to allow for the repurchase of an additional 200,000 shares of common stock after that date. These authorizations do not have expiration dates. As common shares are repurchased under this plan, they are retired and revert back to the status of authorized, but unissued common shares.

The following table provides information for the three month period ended March 31, 2017, with respect to this plan:



	Common Shares Repurchased			Total Number of Common Shares Purchased as Part of Publicly Announced Plan or Program	Maximum Number of Common Shares That May Yet Be Purchased Under the Plans or Programs
	Number	Average Price Per Common Share
Balance, December 31					199,957
January 1 -31	11,351	$	27.93	11,351	188,606
February 1 - 28	16,633	28.02		16,633	171,973
March 1 - 31	13,831	27.91		13,831	158,142
Balance, March 31	41,815	$	27.96	41,815	158,142

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

Not applicable.

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Item 6. Exhibits.

(a) Exhibits



Exhibit Number		Exhibits

31(a)		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Executive Officer

31(b)		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Financial Officer

32		Section 1350 Certification of Principal Executive Officer and Principal Financial Officer

101.1*		101.INS (XBRL Instance Document)

		101.SCH (XBRL Taxonomy Extension Schema Document)

		101.CAL (XBRL Calculation Linkbase Document)

		101.LAB (XBRL Taxonomy Label Linkbase Document)

		101.DEF (XBRL Taxonomy Linkbase Document)

		101.PRE (XBRL Taxonomy Presentation Linkbase Document)

In accordance with Rule 406T of Regulations S-T, the XBRL related information shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		Isabella Bank Corporation

Date:	May 5, 2017		/s/ Jae A. Evans
			Jae A. Evans
			President, Chief Executive Officer
			(Principal Executive Officer)

Date:	May 5, 2017		/s/ Rhonda S. Tudor
			Rhonda S. Tudor
			Interim Chief Financial Officer
			(Principal Financial Officer, Principal Accounting Officer)