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ISABELLA BANK Corp - Quarter Report: 2020 June (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 June 30, 2020
or
¨
Transition Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File Number: 0-18415
 
Isabella Bank Corporation
(Exact name of registrant as specified in its charter)
 
Michigan
 
38-2830092
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
401 N. Main St, Mt. Pleasant, MI
 
48858
(Address of principal executive offices)
 
(Zip code)
(989) 772-9471
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
None
N/A
N/A
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ý  Yes    ¨  No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    ý  Yes    ¨  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
 
Accelerated filer
 
¨
 
 
 
 
 
Non-accelerated filer
 
ý
 
Smaller reporting company
 
ý
 
 
 
 
 
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨  Yes   ý  No
The number of common shares outstanding of the registrant’s Common Stock (no par value) was 7,978,097 as of July 28, 2020.



ISABELLA BANK CORPORATION
QUARTERLY REPORT ON FORM 10-Q
Table of Contents

2


Forward Looking Statements
This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended and Rule 3b-6 promulgated thereunder. We intend such forward looking statements to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, and are included in this statement for purposes of these safe harbor provisions. Forward looking statements, which are based on certain assumptions and describe future plans, strategies and expectations, are generally identifiable by use of the words “believe”, “expect”, “intend”, “anticipate”, “estimate”, “project”, or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, federal or state tax laws, monetary and fiscal policy, a health crisis, the quality or composition of the loan or investment portfolio, demand for loan products, fluctuation in the value of collateral securing our loan portfolio, deposit flows, competition, cybersecurity risk, demand for financial services in our market area, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward looking statements and undue reliance should not be placed on such statements. Further information concerning our business, including additional factors that could materially affect our financial results, is included in our filings with the SEC.
Glossary of Acronyms and Abbreviations
The acronyms and abbreviations identified below may be used throughout this Quarterly Report on Form 10-Q or in our other SEC filings. You may find it helpful to refer back to this page while reading this report.
ACL: Allowance for credit losses
 
GAAP: U.S. generally accepted accounting principles
AFS: Available-for-sale
 
IFRS: International Financial Reporting Standards
ALLL: Allowance for loan and lease losses
 
IRR: Interest rate risk
AOCI: Accumulated other comprehensive income
 
ISDA: International Swaps and Derivatives Association
ASC: FASB Accounting Standards Codification
 
LIBOR: London Interbank Offered Rate
ASU: FASB Accounting Standards Update
 
N/A: Not applicable
ATM: Automated teller machine
 
N/M: Not meaningful
BHC Act: Bank Holding Company Act of 1956
 
NAV: Net asset value
CARES Act: Coronavirus Aid, Relief, and Economic Security Act
 
NSF: Non-sufficient funds
CECL: Current expected credit losses
 
OCI: Other comprehensive income (loss)
CFPB: Consumer Financial Protection Bureau
 
OMSR: Originated mortgage servicing rights
CIK: Central Index Key
 
OREO: Other real estate owned
COVID-19: Coronavirus disease 2019
 
OTTI: Other-than-temporary impairment
CRA: Community Reinvestment Act
 
PBO: Projected benefit obligation
DIF: Deposit Insurance Fund
 
PCAOB: Public Company Accounting Oversight Board
DIFS: Department of Insurance and Financial Services
 
PPP: Paycheck Protection Program
Directors Plan: Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors
 
Rabbi Trust: A trust established to fund our Directors Plan
Dividend Reinvestment Plan: Isabella Bank Corporation Stockholder Dividend Reinvestment Plan and Employee Stock Purchase Plan
 
RSP: Isabella Bank Corporation Restricted Stock Plan
Exchange Act: Securities Exchange Act of 1934
 
SBA: Small Business Administration
FASB: Financial Accounting Standards Board
 
SEC: U.S. Securities and Exchange Commission
FDIC: Federal Deposit Insurance Corporation
 
SOX: Sarbanes-Oxley Act of 2002
FFIEC: Federal Financial Institutions Examinations Council
 
Tax Act: Tax Cuts and Jobs Act, enacted December 22, 2017
FRB: Federal Reserve Bank
 
TDR: Troubled debt restructuring
FHLB: Federal Home Loan Bank
 
XBRL: eXtensible Business Reporting Language
Freddie Mac: Federal Home Loan Mortgage Corporation
 
Yield Curve: U.S. Treasury Yield Curve
FTE: Fully taxable equivalent
 
 

3


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

June 30
2020
 
December 31
2019
ASSETS
 
 
 
Cash and cash equivalents
 
 
 
Cash and demand deposits due from banks
$
23,999

 
$
20,311

Interest bearing balances due from banks
85,385

 
40,261

Total cash and cash equivalents
109,384

 
60,572

AFS securities, at fair value
380,414

 
429,839

Mortgage loans AFS
5,451

 
904

Loans
 
 
 
Commercial
799,632

 
700,941

Agricultural
103,162

 
116,920

Residential real estate
307,926

 
298,569

Consumer
73,665

 
70,140

Gross loans
1,284,385

 
1,186,570

Less allowance for loan and lease losses
8,877

 
7,939

Net loans
1,275,508

 
1,178,631

Premises and equipment
25,742

 
26,242

Corporate owned life insurance policies
28,001

 
28,455

Accrued interest receivable
7,715

 
6,501

Equity securities without readily determinable fair values
21,660

 
21,629

Goodwill and other intangible assets
48,353

 
48,379

Other assets
10,999

 
13,046

TOTAL ASSETS
$
1,913,227

 
$
1,814,198

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits
 
 
 
Noninterest bearing
$
340,321

 
$
249,152

Interest bearing demand deposits
263,567

 
229,865

Certificates of deposit under $250 and other savings
746,195

 
739,023

Certificates of deposit over $250
90,595

 
95,811

Total deposits
1,440,678

 
1,313,851

Borrowed funds
236,268

 
275,999

Accrued interest payable and other liabilities
16,290

 
14,166

Total liabilities
1,693,236

 
1,604,016

Shareholders’ equity
 
 
 
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,977,019 shares (including 58,690 shares held in the Rabbi Trust) in 2020 and 7,910,804 shares (including 27,069 shares held in the Rabbi Trust) in 2019
141,701

 
141,069

Shares to be issued for deferred compensation obligations
4,822

 
5,043

Retained earnings
65,101

 
62,099

Accumulated other comprehensive income (loss)
8,367

 
1,971

Total shareholders’ equity
219,991

 
210,182

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,913,227

 
$
1,814,198





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

4


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

Three Months Ended 
 June 30
 
Six Months Ended 
 June 30
 
2020
 
2019
 
2020
 
2019
Interest income
 
 
 
 
 
 
 
Loans, including fees
$
13,297

 
$
13,587

 
$
26,551

 
$
26,478

AFS securities
 
 
 
 
 
 
 
Taxable
1,352

 
1,873

 
2,841

 
3,831

Nontaxable
986

 
1,207

 
2,039

 
2,460

Federal funds sold and other
234

 
148

 
639

 
527

Total interest income
15,869

 
16,815

 
32,070

 
33,296

Interest expense
 
 
 
 
 
 
 
Deposits
2,247

 
2,865

 
5,038

 
5,583

Borrowings
1,318

 
1,662

 
2,726

 
3,236

Total interest expense
3,565

 
4,527

 
7,764

 
8,819

Net interest income
12,304

 
12,288

 
24,306

 
24,477

Provision for loan losses
105

 
(179
)
 
893

 
(145
)
Net interest income after provision for loan losses
12,199

 
12,467

 
23,413

 
24,622

Noninterest income
 
 
 
 
 
 
 
Service charges and fees
1,386

 
1,540

 
2,739

 
3,001

Wealth management fees
656

 
780

 
1,228

 
1,457

Gains from redemption of corporate owned life insurance policies
349

 

 
873

 

Net gain on sale of mortgage loans
466

 
116

 
617

 
209

Earnings on corporate owned life insurance policies
189

 
201

 
371

 
374

Other
200

 
374

 
416

 
449

Total noninterest income
3,246

 
3,011

 
6,244

 
5,490

Noninterest expenses
 
 
 
 
 
 
 
Compensation and benefits
5,793

 
5,957

 
11,662

 
11,679

Furniture and equipment
1,431

 
1,409

 
2,892

 
2,903

Occupancy
912

 
834

 
1,779

 
1,764

Other
2,564

 
2,549

 
5,312

 
5,192

Total noninterest expenses
10,700

 
10,749

 
21,645

 
21,538

Income before federal income tax expense
4,745

 
4,729

 
8,012

 
8,574

Federal income tax expense
558

 
541

 
761

 
890

NET INCOME
$
4,187

 
$
4,188

 
$
7,251

 
$
7,684

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.53

 
$
0.53

 
$
0.91

 
$
0.97

Diluted
$
0.52

 
$
0.52

 
$
0.90

 
$
0.95

Cash dividends per common share
$
0.27

 
$
0.26

 
$
0.54

 
$
0.52






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

5


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

Three Months Ended 
 June 30
 
Six Months Ended 
 June 30
 
2020
 
2019
 
2020
 
2019
Net income
$
4,187

 
$
4,188

 
$
7,251

 
$
7,684

Unrealized gains (losses) on AFS securities arising during the period
2,059

 
4,876

 
8,370

 
10,830

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

 

 
(71
)
 

Tax effect (1)
(379
)
 
(1,018
)
 
(1,772
)
 
(2,213
)
Unrealized gains (losses) on AFS securities, net of tax
1,680

 
3,858

 
6,527

 
8,617

Unrealized gains (losses) on derivative instruments arising during the period
(29
)
 
(127
)
 
(165
)
 
(208
)
Tax effect (1)
6

 
26

 
34

 
43

Unrealized gains (losses) on derivative instruments, net of tax
(23
)
 
(101
)
 
(131
)
 
(165
)
Other comprehensive income (loss), net of tax
1,657

 
3,757

 
6,396

 
8,452

Comprehensive income (loss)
$
5,844

 
$
7,945

 
$
13,647

 
$
16,136

(1) 
See “Note 10 – Accumulated Other Comprehensive Income” for tax effect reconciliation.




















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

6


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

Common Shares
Outstanding
 
Amount
 
Common Shares to be
Issued for
Deferred
Compensation
Obligations
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Totals
Balance, January 1, 2019
7,870,969

 
$
140,416

 
$
5,431

 
$
57,357

 
$
(7,685
)
 
$
195,519

Comprehensive income (loss)

 

 

 
7,684

 
8,452

 
16,136

Issuance of common stock
104,598

 
2,436

 

 

 

 
2,436

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

 
268

 
(268
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
271

 

 

 
271

Common stock purchased for deferred compensation obligations

 
(816
)
 

 

 

 
(816
)
Common stock repurchased pursuant to publicly announced repurchase plan
(57,073
)
 
(1,339
)
 

 

 

 
(1,339
)
Cash dividends paid ($0.52 per common share)

 

 

 
(4,093
)
 

 
(4,093
)
Balance, June 30, 2019
7,918,494

 
$
140,965

 
$
5,434

 
$
60,948

 
$
767

 
$
208,114

Balance, January 1, 2020
7,910,804

 
$
141,069

 
$
5,043

 
$
62,099

 
$
1,971

 
$
210,182

Comprehensive income (loss)

 

 

 
7,251

 
6,396

 
13,647

Issuance of common stock
127,216

 
2,343

 

 

 

 
2,343

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

 
454

 
(454
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
233

 

 

 
233

Common stock purchased for deferred compensation obligations

 
(970
)
 

 

 

 
(970
)
Common stock repurchased pursuant to publicly announced repurchase plan
(61,001
)
 
(1,195
)
 

 

 

 
(1,195
)
Cash dividends paid ($0.54 per common share)

 

 

 
(4,249
)
 

 
(4,249
)
Balance, June 30, 2020
7,977,019

 
$
141,701

 
$
4,822

 
$
65,101

 
$
8,367

 
$
219,991
















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

7


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

Six Months Ended 
 June 30
 
2020
 
2019
OPERATING ACTIVITIES
 
 
 
Net income
$
7,251

 
$
7,684

Reconciliation of net income to net cash provided by operating activities:
 
 
 
Undistributed earnings of equity securities without readily determinable fair values
(31
)
 
(76
)
Provision for loan losses
893

 
(145
)
Depreciation
1,319

 
1,476

Amortization of OMSR
302

 
118

Amortization of acquisition intangibles
26

 
38

Net amortization of AFS securities
925

 
882

Net gains on sale of AFS securities
(71
)
 

Net gain on sale of mortgage loans
(617
)
 
(209
)
OMSR impairment loss
316

 
44

Net gains on foreclosed assets
(43
)
 
(11
)
Increase in cash value of corporate owned life insurance policies, net of expenses
(233
)
 
(357
)
Gains from redemption of corporate owned life insurance policies
(873
)
 

Share-based payment awards under equity compensation plan
233

 
271

Origination of loans held-for-sale
(49,092
)
 
(14,110
)
Proceeds from loan sales
45,162

 
13,305

Net changes in operating assets and liabilities which provided (used) cash:
 
 
 
Accrued interest receivable
(1,214
)
 
735

Other assets
1,686

 
1,700

Accrued interest payable and other liabilities
667

 
756

Net cash provided by (used in) operating activities
6,606

 
12,101

INVESTING ACTIVITIES
 
 
 
Activity in AFS securities
 
 
 
Sales
26,855

 

Maturities, calls, and principal payments
47,027

 
43,296

Purchases
(17,012
)
 
(8,963
)
Net loan principal (originations) collections
(98,131
)
 
(48,585
)
Proceeds from sales of foreclosed assets
84

 
330

Purchases of premises and equipment
(819
)
 
(615
)
Purchases of corporate owned life insurance policies
(625
)
 

Proceeds from redemption of corporate owned life insurance policies
2,185

 

Funding of low income housing tax credit investments
(383
)
 
(149
)
Net cash provided by (used in) investing activities
(40,819
)
 
(14,686
)

8


INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
 
Six Months Ended 
 June 30
 
2020
 
2019
FINANCING ACTIVITIES
 
 
 
Net increase (decrease) in deposits
126,827

 
(11,275
)
Net increase (decrease) in borrowed funds
(39,731
)
 
(19,837
)
Cash dividends paid on common stock
(4,249
)
 
(4,093
)
Proceeds from issuance of common stock
2,343

 
2,436

Common stock repurchased
(1,195
)
 
(1,339
)
Common stock purchased for deferred compensation obligations
(970
)
 
(816
)
Net cash provided by (used in) financing activities
83,025

 
(34,924
)
Increase (decrease) in cash and cash equivalents
48,812

 
(37,509
)
Cash and cash equivalents at beginning of period
60,572

 
73,471

Cash and cash equivalents at end of period
$
109,384


$
35,962

SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Interest paid
$
7,957

 
$
8,760

SUPPLEMENTAL NONCASH INFORMATION:
 
 
 
Transfers of loans to foreclosed assets
$
361

 
$
477





















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

9


NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Dollars in thousands except per share amounts)
Note 1 – Basis of Presentation
As used in these notes, as well as in Management's Discussion and Analysis of Financial Condition and Results of Operations, references to the “Corporation”, “Isabella”, “we”, “our”, “us”, and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiary. References to Isabella Bank or the “Bank” refer to Isabella Bank Corporation’s subsidiary, Isabella Bank.
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and six-month periods ended June 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2019.
Our accounting policies are materially the same as those discussed in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2019.
Reclassifications: Certain amounts reported in the interim 2019 consolidated financial statements have been reclassified to conform with the 2020 presentation.
Note 2 – Accounting Standards Updates
Recently Adopted
ASU No. 2018-13: “Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement”
In August 2018, ASU No. 2018-13 was issued and provided an updated framework related to fair value disclosures. For entities required to make disclosures about recurring or nonrecurring fair value measurements, the update provides disclosure modifications which include the removal, modification and addition of specific disclosure requirements.
The new authoritative guidance was effective January 1, 2020 and did not have a significant impact on our financial statement disclosures.
ASU No. 2018-15: “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract”
In August 2018, ASU No. 2018-15 was issued and provided guidance on the accounting for implementation, setup, and
other upfront costs (collectively referred to as implementation costs) for entities that are a customer in a hosting arrangement that is a service contract. The guidance also provided clarification on requirements to capitalize implementation costs and the required accounting for expenses related to capitalization of implementation costs.
The new authoritative guidance was effective January 1, 2020. We will review arrangements entered into prospectively. These changes are not expected to have a significant impact on our operating results or financial statement disclosures.
Pending
ASU No. 2016-13: “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”, as amended
In June 2016, ASU No. 2016-13 was issued and updated the measurement for credit losses for AFS debt securities and assets measured at amortized cost which include loans, trade receivables, and any other financial assets with the contractual right to receive cash. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. Under the incurred loss approach, entities are limited to a probable initial recognition threshold when credit losses are measured; an entity generally only considers past events and current conditions in measuring the incurred loss.

10


Under the new guidance, the incurred loss impairment methodology is replaced with a methodology that reflects current expected credit losses (CECL). This methodology requires consideration of a broader range of reasonable and supportable information to calculate credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances which applies to assets measured either collectively or individually.
The update allows an entity to revert to historical loss information that is reflective of the contractual term (considering the effect of prepayments) for periods that are beyond the time frame for which the entity is able to develop reasonable and supportable forecasts. In addition, the disclosures of credit quality indicators in relation to the amortized cost of financing receivables, a current disclosure requirement, are further disaggregated by year of origination (or vintage). The vintage information will be useful for financial statement users to better assess changes in underwriting standards and credit quality trends in asset portfolios over time and the effect of those changes on credit losses.
Overall, the update will allow entities the ability to measure expected credit losses without the restriction of incurred or probable losses that exist under current GAAP. For users of the financial statements, the update requires disclosure of decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The new authoritative guidance was originally effective for interim and annual periods beginning after December 15, 2019. Effective October 16, 2019, the FASB approved and issued changes to the implementation date of this guidance for some filers. As a small reporting company, as defined by the SEC, our implementation date was delayed from January 1, 2020 to January 1, 2023. Early adoption continues to be permissible under the revised implementation date; currently we have no plans for early adoption. This guidance may have a significant impact on the results of our operations and financial statement disclosures as well as that of the banking industry as a whole.
We have invested a considerable amount of effort toward this guidance and will continue to invest considerable effort until our implementation date. An internal committee was formed and is accountable for timely and accurate adoption of the guidance. A service provider that has focused on the ALLL for more than 10 years and serves hundreds of financial institutions has been engaged to provide us with education, advisory, and software solutions exclusively related to the ACL. We will run parallel processes which will help to ensure we are ready to calculate, review, and report the ACL by the required implementation date.
ASU No. 2018-14: “Compensation - Retirement Benefits - Defined Pension Plans - General (Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans”
In August 2018, ASU No. 2018-14 was issued and provided an updated framework related to defined benefit plans. For employers that sponsor defined benefit pension or other postretirement plans, the update provides disclosure modifications which include the removal of six specific requirements, the addition of two specific requirements and clarification to existing requirements.
Disclosure additions include 1) the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates; and 2) an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. Clarification items relate to 1) the projected benefit obligation (PBO) and fair value of plan assets for plans with PBOs in excess of plan assets; and 2) the accumulated benefit obligation (ABO) and fair value of plan assets for plans with ABOs in excess of plan assets.
The new authoritative guidance is effective for fiscal years ending after December 15, 2020, with early adoption permitted, and will likely impact our financial statement disclosures.

11


Note 3 – AFS Securities
The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:
 
June 30, 2020

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
States and political subdivisions
$
141,246

 
$
5,539

 
$

 
$
146,785

Auction rate money market preferred
3,200

 

 
221

 
2,979

Mortgage-backed securities
115,224

 
3,805

 

 
119,029

Collateralized mortgage obligations
106,586

 
5,035

 

 
111,621

Total
$
366,256

 
$
14,379

 
$
221

 
$
380,414

 
December 31, 2019

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
States and political subdivisions
$
165,005

 
$
4,747

 
$

 
$
169,752

Auction rate money market preferred
3,200

 

 
81

 
3,119

Mortgage-backed securities
139,831

 
933

 
560

 
140,204

Collateralized mortgage obligations
115,944

 
1,007

 
187

 
116,764

Total
$
423,980

 
$
6,687

 
$
828

 
$
429,839

The amortized cost and fair value of AFS securities by contractual maturity at June 30, 2020 are as follows:
 
Maturing
 
Securities with Variable Monthly Payments or Noncontractual Maturities
 
 

Due in
One Year
or Less
 
After One
Year But
Within
Five Years
 
After Five
Years But
Within
Ten Years
 
After
Ten Years
 
 
Total
States and political subdivisions
$
19,603

 
$
65,321

 
$
30,558

 
$
25,764

 
$

 
$
141,246

Auction rate money market preferred

 

 

 

 
3,200

 
3,200

Mortgage-backed securities

 

 

 

 
115,224

 
115,224

Collateralized mortgage obligations

 

 

 

 
106,586

 
106,586

Total amortized cost
$
19,603

 
$
65,321

 
$
30,558

 
$
25,764

 
$
225,010

 
$
366,256

Fair value
$
19,738

 
$
67,281

 
$
32,133

 
$
27,633

 
$
233,629

 
$
380,414

Expected maturities for government sponsored enterprises and states and political subdivisions may differ from contractual maturities because issuers may have the right to call or prepay obligations.
As the auction rate money market preferred investments have continual call dates, they are not reported by a specific maturity group. Because of their variable monthly payments, mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group.
A summary of the sales activity of AFS securities was as follows for the:
 
Three Months Ended June 30
 
Six Months Ended June 30
 
2020
 
2019
 
2020
 
2019
Proceeds from sales of AFS securities
$

 
$

 
$
26,855

 
$

Realized gains (losses)
$

 
$

 
$
71

 
$

Applicable income tax expense (benefit)
$

 
$

 
$
15

 
$


12


The following information pertains to AFS securities with gross unrealized losses at June 30, 2020 and December 31, 2019, aggregated by investment category and length of time that individual securities have been in a continuous loss position.
 
June 30, 2020
 
Less Than Twelve Months
 
Twelve Months or More
 
 

Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total
Unrealized
Losses
Auction rate money market preferred
$

 
$

 
$
221

 
$
2,979

 
221

Number of securities in an unrealized loss position:
 
 

 
 
 
2

 
2

 
December 31, 2019
 
Less Than Twelve Months
 
Twelve Months or More
 
 

Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total
Unrealized
Losses
Auction rate money market preferred
$

 
$

 
$
81

 
$
3,119

 
$
81

Mortgage-backed securities
3

 
3,974

 
557

 
49,701

 
560

Collateralized mortgage obligations
43

 
20,262

 
144

 
13,309

 
187

Total
$
46

 
$
24,236

 
$
782

 
$
66,129

 
$
828

Number of securities in an unrealized loss position:
 
 
9

 
 
 
19

 
28

The reduction in unrealized losses on our AFS securities portfolio resulted from recent decreases in intermediate-term and long-term benchmark interest rates.
As of June 30, 2020 and December 31, 2019, we conducted an analysis to determine whether any AFS securities currently in an unrealized loss position should be identified as other-than-temporarily impaired. Such analyses considered, among other factors, the following criteria:
Has the value of the investment declined more than what is deemed to be reasonable based on a risk and maturity adjusted discount rate?
Is the investment credit rating below investment grade?
Is it probable the issuer will be unable to pay the amount when due?
Is it more likely than not that we will have to sell the security before recovery of its cost basis?
Has the duration of the investment been extended?
Based on our analysis, which included the criteria outlined above and the fact that we have asserted that we do not have to sell any AFS securities in an unrealized loss position, we do not believe that the values of any AFS securities are other-than-temporarily impaired as of June 30, 2020 or December 31, 2019, with the exception of one municipal bond previously identified which had no activity during the period.

13


Note 4 – Loans and ALLL
We grant commercial, agricultural, residential real estate, and consumer loans to customers situated primarily in Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties in Michigan. The ability of the borrowers to honor their repayment obligations is often dependent upon the real estate, agricultural, manufacturing, retail, gaming, tourism, health care, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees. A portion of loans are unsecured.
Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and deferred fees or costs. Unless a loan has a nonaccrual status, interest income is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the appropriate amortization method.
The accrual of interest on commercial and agricultural loans, as well as residential real estate loans, is discontinued at the time a loan is 90 days or more past due unless the credit is well-secured and in the process of short-term collection. Upon transferring a loan to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if a charge-off is necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on the contractual term of the loan. In all cases, a loan is placed in nonaccrual status at an earlier date if collection of principal or interest is considered doubtful.
When a loan is placed in nonaccrual status, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the ALLL. Loans may be returned to accrual status after six months of continuous performance and achievement of current payment status.
Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, advances to mortgage brokers, farmland and agricultural production, and loans to states and political subdivisions. Repayment of these loans is dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of direct credit exposure to any one borrower to $15,000. Borrowers with direct credit needs of more than $15,000 may be serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans commonly require loan-to-value limits of 80% or less. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, property, or equipment. Government agency guarantee may be required. Personal guarantees and/or life insurance beneficiary assignments are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we may require annual financial statements, prepare cash flow analyses, and review credit reports.
We entered into a mortgage purchase program in 2016 with a financial institution where we participate in advances to mortgage brokers (“advances”). The mortgage brokers originate residential mortgage loans with the intent to sell them on the secondary market. We participate in the advance to the mortgage broker, which is secured by the underlying mortgage loan, until it is ultimately sold on the secondary market. As such, the average life of each participated advance is approximately 20-30 days. Funds from the sale of the loan are used to pay off our participation in the advance to the mortgage broker. We classify these advances as commercial loans and include the outstanding balance in commercial loans on our consolidated balance sheets. Under the participation agreement, we committed to a maximum outstanding aggregate amount of $50,000. The difference between our outstanding balance and the maximum outstanding aggregate amount is classified as “Unfunded commitments under lines of credit” in the “Contractual Obligations and Loan Commitments” section of the Management's Discussion and Analysis of Financial Condition and Results of Operations of this report.
We offer adjustable rate mortgages, construction loans, and fixed rate residential real estate loans which have amortization periods up to a maximum of 30 years. We consider the anticipated direction of interest rates, balance sheet duration, the sensitivity of our balance sheet to changes in interest rates, our liquidity needs, and overall loan demand to determine whether or not to sell fixed rate loans to Freddie Mac.
Our lending policies generally limit the maximum loan-to-value ratio on residential real estate loans to 100% of the lower of the appraised value of the property or the purchase price. Private mortgage insurance is typically required on loans with loan-to-value ratios in excess of 80% unless the loan qualifies for government guarantees.

14


Underwriting criteria for originated residential real estate loans generally include:
Evaluation of the borrower’s ability to make monthly payments.
Evaluation of the value of the property securing the loan.
Ensuring the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower’s gross income.
Ensuring all debt servicing does not exceed 40% of income.
Verification of acceptable credit reports.
Verification of employment, income, and financial information.
Appraisals are performed by independent appraisers and are reviewed for appropriateness. Generally, mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market underwriting system; loans in excess of $1,000 require the approval of our Internal Loan Committee, the Executive Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors.
Consumer loans include secured and unsecured personal loans. Loans are amortized for a period of up to 15 years based on the age and value of the underlying collateral. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market.
The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Full or partial loan balances are charged against the ALLL when we believe uncollectability is probable. Subsequent recoveries, if any, are credited to the ALLL.
The ALLL is evaluated on a regular basis for appropriateness. Our periodic review of the collectability of a loan considers historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. Specific allocations for impaired loans are primarily determined based on the difference between the loan’s outstanding balance and the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral, less costs to sell, if the loan is collateral dependent. Historical loss allocations are calculated at the loan class and segment levels based on a migration analysis of the loan portfolio, with the exception of advances to mortgage brokers, over the preceding five years. With no historical losses on advances to mortgage brokers, there is no allocation related to this portfolio. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong at June 30, 2020. However, the COVID-19 pandemic led to temporary closures of businesses throughout the communities in which we serve, which also led to increased unemployment. Therefore, we increased the ALLL during the first six months of 2020 to account for inherent risk of probable losses within the loan portfolio as of June 30, 2020. We continue to monitor the economic impact from COVID-19 as it relates to credit risk to ensure the ALLL is appropriate.
Summaries of the ALLL and the recorded investment in loans by segments follows:
 
Allowance for Loan Losses
 
Three Months Ended June 30, 2020

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
April 1, 2020
$
2,375

 
$
490

 
$
1,717

 
$
961

 
$
3,154

 
$
8,697

Charge-offs
(1
)
 
(6
)
 

 
(59
)
 

 
(66
)
Recoveries
30

 
2

 
39

 
70

 

 
141

Provision for loan losses
(283
)
 
(130
)
 
(563
)
 
(147
)
 
1,228

 
105

June 30, 2020
$
2,121

 
$
356

 
$
1,193

 
$
825

 
$
4,382

 
$
8,877


15


 
Allowance for Loan Losses

Six Months Ended June 30, 2020

Commercial

Agricultural

Residential Real Estate

Consumer

Unallocated

Total
January 1, 2020
$
1,914


$
634


$
2,047


$
922


$
2,422


$
7,939

Charge-offs
(5
)

(22
)

(15
)

(182
)



(224
)
Recoveries
52


35


66


116




269

Provision for loan losses
160


(291
)

(905
)

(31
)

1,960


893

June 30, 2020
$
2,121


$
356


$
1,193


$
825


$
4,382


$
8,877

 
Allowance for Loan Losses and Recorded Investment in Loans
 
June 30, 2020

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
63

 
$
63

 
$
824

 
$

 
$

 
$
950

Collectively evaluated for impairment
2,058

 
293

 
369

 
825

 
4,382

 
7,927

Total
$
2,121

 
$
356

 
$
1,193

 
$
825

 
$
4,382

 
$
8,877

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
8,235

 
$
13,191

 
$
4,926

 
$

 
 
 
$
26,352

Collectively evaluated for impairment
791,397

 
89,971

 
303,000

 
73,665

 
 
 
1,258,033

Total
$
799,632

 
$
103,162

 
$
307,926

 
$
73,665

 
 
 
$
1,284,385

 
Allowance for Loan Losses
 
Three Months Ended June 30, 2019

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
April 1, 2019
$
2,248

 
$
775

 
$
2,305

 
$
891

 
$
2,179

 
$
8,398

Charge-offs
(105
)
 
(59
)
 
(94
)
 
(75
)
 

 
(333
)
Recoveries
22

 

 
91

 
38

 

 
151

Provision for loan losses
(85
)
 
(104
)
 
(420
)
 
73

 
357

 
(179
)
June 30, 2019
$
2,080

 
$
612

 
$
1,882

 
$
927

 
$
2,536

 
$
8,037

 
Allowance for Loan Losses
 
Six Months Ended June 30, 2019

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
January 1, 2019
$
2,563

 
$
775

 
$
1,992

 
$
857

 
$
2,188

 
$
8,375

Charge-offs
(113
)
 
(59
)
 
(96
)
 
(203
)
 

 
(471
)
Recoveries
73

 
1

 
118

 
86

 

 
278

Provision for loan losses
(443
)
 
(105
)
 
(132
)
 
187

 
348

 
(145
)
June 30, 2019
$
2,080

 
$
612

 
$
1,882

 
$
927

 
$
2,536

 
$
8,037


16


 
Allowance for Loan Losses and Recorded Investment in Loans
 
December 31, 2019

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
15

 
$
26

 
$
1,073

 
$

 
$

 
$
1,114

Collectively evaluated for impairment
1,899

 
608

 
974

 
922

 
2,422

 
6,825

Total
$
1,914

 
$
634

 
$
2,047

 
$
922

 
$
2,422

 
$
7,939

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
7,865

 
$
14,840

 
$
5,486

 
$

 
 
 
$
28,191

Collectively evaluated for impairment
693,076

 
102,080

 
293,083

 
70,140

 
 
 
1,158,379

Total
$
700,941


$
116,920

 
$
298,569

 
$
70,140

 
 
 
$
1,186,570

The following tables display the internally assigned credit risk ratings for commercial and agricultural credit exposures as of:
 
June 30, 2020
 
Commercial
 
Agricultural
 
 

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

 
 
1 - Excellent
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

2 - High quality
3,004

 
18,584

 

 
21,588

 
836

 
13

 
849

 
22,437

3 - High satisfactory
90,236

 
65,092

 
46,767

 
202,095

 
16,983

 
5,528

 
22,511

 
224,606

4 - Low satisfactory
385,803

 
147,480

 

 
533,283

 
32,165

 
18,466

 
50,631

 
583,914

5 - Special mention
17,843

 
9,346

 

 
27,189

 
12,528

 
2,865

 
15,393

 
42,582

6 - Substandard
7,126

 
6,984

 

 
14,110

 
6,763

 
3,359

 
10,122

 
24,232

7 - Vulnerable
28

 
1,339

 

 
1,367

 
2,916

 
552

 
3,468

 
4,835

8 - Doubtful

 

 

 

 
188

 

 
188

 
188

9 - Loss

 

 

 

 

 

 

 

Total
$
504,040

 
$
248,825

 
$
46,767

 
$
799,632

 
$
72,379

 
$
30,783

 
$
103,162

 
$
902,794

 
December 31, 2019
 
Commercial
 
Agricultural
 
 

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

 
$
390

 
$

 
$
390

 
$

 
$

 
$

 
$
390

2 - High quality
2,582

 
8,844

 

 
11,426

 
1,452

 
99

 
1,551

 
12,977

3 - High satisfactory
109,737

 
42,858

 
35,523

 
188,118

 
16,765

 
6,769

 
23,534

 
211,652

4 - Low satisfactory
377,198

 
94,847

 

 
472,045

 
42,798

 
20,861

 
63,659

 
535,704

5 - Special mention
15,372

 
3,470

 

 
18,842

 
7,165

 
3,754

 
10,919

 
29,761

6 - Substandard
4,874

 
3,625

 

 
8,499

 
9,136

 
3,836

 
12,972

 
21,471

7 - Vulnerable
390

 
1,231

 

 
1,621

 
2,711

 
1,574

 
4,285

 
5,906

8 - Doubtful

 

 

 

 

 

 



9 - Loss

 

 

 

 

 

 

 

Total
$
510,153

 
$
155,265

 
$
35,523

 
$
700,941

 
$
80,027

 
$
36,893

 
$
116,920


$
817,861


17


Internally assigned credit risk ratings are reviewed, at a minimum, when loans are renewed or when management has knowledge of improvements or deterioration of the credit quality of individual credits. Descriptions of the internally assigned credit risk ratings for commercial and agricultural loans are as follows:
1. EXCELLENT – Substantially Risk Free
Credit has strong financial condition and solid earnings history, characterized by:
High liquidity, strong cash flow, low leverage.
Unquestioned ability to meet all obligations when due.
Experienced management, with management succession in place.
Secured by cash.
2. HIGH QUALITY – Limited Risk
Credit with sound financial condition and a positive trend in earnings supplemented by:
Favorable liquidity and leverage ratios.
Ability to meet all obligations when due.
Management with successful track record.
Steady and satisfactory earnings history.
If loan is secured, collateral is of high quality and readily marketable.
Access to alternative financing.
Well defined primary and secondary source of repayment.
If supported by guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident.
3. HIGH SATISFACTORY – Reasonable Risk
Credit with satisfactory financial condition and further characterized by:
Working capital adequate to support operations.
Cash flow sufficient to pay debts as scheduled.
Management experience and depth appear favorable.
Loan performing according to terms.
If loan is secured, collateral is acceptable and loan is fully protected.
4. LOW SATISFACTORY – Acceptable Risk
Credit with bankable risks, although some signs of weaknesses are shown:
Would include most start-up businesses.
Occasional instances of trade slowness or repayment delinquency – may have been 10-30 days slow within the past year.
Management’s abilities are apparent yet unproven.
Weakness in primary source of repayment with adequate secondary source of repayment.
Loan structure generally in accordance with policy.
If secured, loan collateral coverage is marginal.
To be classified as less than satisfactory, only one of the following criteria must be met.
5. SPECIAL MENTION – Criticized
Credit constitutes an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitutes an unwarranted risk in light of the circumstances surrounding a specific loan:
Downward trend in sales, profit levels, and margins.
Impaired working capital position.
Cash flow is strained in order to meet debt repayment.
Loan delinquency (30-60 days) and overdrafts may occur.
Shrinking equity cushion.

18


Diminishing primary source of repayment and questionable secondary source.
Management abilities are questionable.
Weak industry conditions.
Litigation pending against the borrower.
Loan may need to be restructured to improve collateral position or reduce payments.
Collateral or guaranty offers limited protection.
Negative debt service coverage, however the credit is well collateralized and payments are current.
6. SUBSTANDARD – Classified
Credit is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged. There is a distinct possibility we will implement collection procedures if the loan deficiencies are not corrected. Any commercial loan placed in nonaccrual status will be rated “7” or worse. In addition, the following characteristics may apply:
Sustained losses have severely eroded the equity and cash flow.
Deteriorating liquidity.
Serious management problems or internal fraud.
Original repayment terms liberalized.
Likelihood of bankruptcy.
Inability to access other funding sources.
Reliance on secondary source of repayment.
Litigation filed against borrower.
Interest non-accrual may be warranted.
Collateral provides little or no value.
Requires excessive attention of the loan officer.
Borrower is uncooperative with loan officer.
7. VULNERABLE – Classified
Credit is considered “Substandard” and warrants placing in nonaccrual status. Risk of loss is being evaluated and exit strategy options are under review. Other characteristics that may apply:
Insufficient cash flow to service debt.
Minimal or no payments being received.
Limited options available to avoid the collection process.
Transition status, expect action will take place to collect loan without immediate progress being made.
8. DOUBTFUL – Workout
Credit has all the weaknesses inherent in a “Substandard” loan with the added characteristic that collection and/or liquidation is pending. The possibility of a loss is extremely high, but its classification as a loss is deferred until liquidation procedures are completed, or reasonably estimable. Other characteristics that may apply:
Normal operations are severely diminished or have ceased.
Seriously impaired cash flow.
Original repayment terms materially altered.
Secondary source of repayment is inadequate.
Survivability as a “going concern” is impossible.
Collection process has begun.
Bankruptcy petition has been filed.
Judgments have been filed.
Portion of the loan balance has been charged-off.

19


9. LOSS – Charge-off
Credit is considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification is for charged-off loans but does not mean that the asset has absolutely no recovery or salvage value. These loans are further characterized by:
Liquidation or reorganization under Bankruptcy, with poor prospects of collection.
Fraudulently overstated assets and/or earnings.
Collateral has marginal or no value.
Debtor cannot be located.
Over 120 days delinquent.
Our primary credit quality indicator for residential real estate and consumer loans is the individual loan’s past due aging. The following tables summarize the past due and current loans for the entire loan portfolio as of:
 
June 30, 2020
 
Accruing Interest
and Past Due:
 
 
 
Total Past Due and Nonaccrual
 
 
 
 

30-59
Days
 
60-89
Days
 
90 Days
or More
 
Nonaccrual
 
 
Current
 
Total
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
51

 
$
46

 
$
53

 
$
28

 
$
178

 
$
503,862

 
$
504,040

Commercial other
220

 
249

 

 
1,339

 
1,808

 
247,017

 
248,825

Advances to mortgage brokers

 

 

 

 

 
46,767

 
46,767

Total commercial
271

 
295

 
53

 
1,367

 
1,986

 
797,646

 
799,632

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate
799

 

 

 
3,104

 
3,903

 
68,476

 
72,379

Agricultural other

 

 

 
552

 
552

 
30,231

 
30,783

Total agricultural
799

 

 

 
3,656

 
4,455

 
98,707

 
103,162

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
74

 

 

 
184

 
258

 
270,436

 
270,694

Junior liens
3

 

 

 

 
3

 
4,715

 
4,718

Home equity lines of credit
11

 

 

 
112

 
123

 
32,391

 
32,514

Total residential real estate
88

 

 

 
296

 
384

 
307,542

 
307,926

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
14

 
27

 

 

 
41

 
70,311

 
70,352

Unsecured
4

 

 

 

 
4

 
3,309

 
3,313

Total consumer
18

 
27

 

 

 
45

 
73,620

 
73,665

Total
$
1,176

 
$
322

 
$
53

 
$
5,319

 
$
6,870

 
$
1,277,515

 
$
1,284,385


20


 
December 31, 2019
 
Accruing Interest
and Past Due:
 
 
 
Total Past Due and Nonaccrual
 
 
 
 

30-59
Days
 
60-89
Days
 
90 Days
or More
 
Nonaccrual
 
 
Current
 
Total
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
139

 
$
30

 
$

 
$
390

 
$
559

 
$
509,594

 
$
510,153

Commercial other
531

 
156

 

 
1,231

 
1,918

 
153,347

 
155,265

Advances to mortgage brokers

 

 

 

 

 
35,523

 
35,523

Total commercial
670

 
186

 

 
1,621

 
2,477

 
698,464

 
700,941

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate

 

 

 
2,711

 
2,711

 
77,316

 
80,027

Agricultural other

 

 

 
1,574

 
1,574

 
35,319

 
36,893

Total agricultural

 

 

 
4,285

 
4,285

 
112,635

 
116,920

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
3,463

 
258

 

 
557

 
4,278

 
253,894

 
258,172

Junior liens
65

 

 

 

 
65

 
5,766

 
5,831

Home equity lines of credit
157

 

 

 
72

 
229

 
34,337

 
34,566

Total residential real estate
3,685

 
258

 

 
629

 
4,572

 
293,997

 
298,569

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
68

 

 

 

 
68

 
66,547

 
66,615

Unsecured
3

 

 

 

 
3

 
3,522

 
3,525

Total consumer
71

 

 

 

 
71

 
70,069

 
70,140

Total
$
4,426

 
$
444

 
$

 
$
6,535

 
$
11,405

 
$
1,175,165

 
$
1,186,570

Impaired Loans
Loans may be classified as impaired if they meet one or more of the following criteria:
1.
There has been a charge-off of its principal balance (in whole or in part);
2.
The loan has been classified as a TDR; or
3.
The loan is in nonaccrual status.
Impairment is measured on a loan-by-loan basis for commercial and agricultural loans by comparing the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral, less costs to sell, if the loan is collateral dependent. Large groups of smaller-balance, homogeneous residential real estate and consumer loans are collectively evaluated for impairment by comparing the loan’s unpaid principal balance to the present value of expected future cash flows discounted at the loan’s effective interest rate.
We do not recognize interest income on impaired loans in nonaccrual status. For impaired loans not classified as nonaccrual, interest income is recognized daily, as earned, according to the terms of the loan agreement and the principal amount outstanding.

21


The following is a summary of impaired loans as of:
 
June 30, 2020
 
December 31, 2019

Recorded Balance
 
Unpaid Principal Balance
 
Valuation Allowance
 
Recorded Balance
 
Unpaid Principal Balance
 
Valuation Allowance
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
1,045

 
$
1,287

 
$
63

 
$
517

 
$
635

 
$
15

Agricultural real estate
2,201

 
2,251

 
61

 
1,509

 
1,509

 
12

Agricultural other
1,355

 
1,355

 
2

 
1,355

 
1,355

 
14

Residential real estate senior liens
4,814

 
5,242

 
824

 
5,401

 
5,830

 
1,073

Total impaired loans with a valuation allowance
9,415

 
10,135

 
950

 
8,782

 
9,329

 
1,114

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
3,930

 
4,004

 
 
 
4,961

 
5,224

 
 
Commercial other
3,260

 
3,260

 
 
 
2,387

 
2,387

 
 
Agricultural real estate
7,689

 
7,689

 
 
 
8,372

 
8,422

 
 
Agricultural other
1,946

 
1,946

 
 
 
3,604

 
3,604

 
 
Home equity lines of credit
112

 
112

 
 
 
85

 
385

 
 
Total impaired loans without a valuation allowance
16,937

 
17,011

 
 
 
19,409

 
20,022

 
 
Impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial
8,235

 
8,551

 
63

 
7,865

 
8,246

 
15

Agricultural
13,191

 
13,241

 
63

 
14,840

 
14,890

 
26

Residential real estate
4,926

 
5,354

 
824

 
5,486

 
6,215

 
1,073

Total impaired loans
$
26,352

 
$
27,146

 
$
950

 
$
28,191

 
$
29,351

 
$
1,114


22


The following is a summary of impaired loans for the:
 
Three Months Ended June 30
 
2020
 
2019

Average Recorded Balance
 
Interest Income Recognized
 
Average Recorded Balance
 
Interest Income Recognized
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
$
1,085

 
$
21

 
$
2,497

 
$
7

Commercial other
460

 

 
11

 

Agricultural real estate
2,224

 
26

 
951

 
57

Agricultural other
1,355

 
20

 
641

 
9

Residential real estate senior liens
5,050

 
49

 
6,439

 
19

Residential real estate junior liens

 

 
12

 

Total impaired loans with a valuation allowance
10,174

 
116

 
10,551

 
92

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
4,046

 
60

 
3,985

 
21

Commercial other
2,826

 
32

 
2,751

 
13

Agricultural real estate
7,441

 
87

 
7,307

 
58

Agricultural other
2,406

 
56

 
4,833

 
86

Home equity lines of credit
101

 
(1
)
 
34

 

Consumer secured
2

 

 
8

 

Total impaired loans without a valuation allowance
16,822

 
234

 
18,918

 
178

Impaired loans
 
 
 
 
 
 
 
Commercial
8,417

 
113

 
9,244

 
41

Agricultural
13,426

 
189

 
13,732

 
210

Residential real estate
5,151

 
48

 
6,485

 
19

Consumer
2

 

 
8

 

Total impaired loans
$
26,996

 
$
350

 
$
29,469

 
$
270


23


 
Six Months Ended June 30
 
2020
 
2019

Average Recorded Balance
 
Interest Income Recognized
 
Average Recorded Balance
 
Interest Income Recognized
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
$
951

 
$
46

 
$
2,952

 
$
56

Commercial other
460

 
6

 
11

 

Agricultural real estate
2,051

 
50

 
671

 
63

Agricultural other
1,355

 
42

 
343

 
9

Residential real estate senior liens
5,197

 
104

 
6,561

 
87

Residential real estate junior liens

 

 
12

 

Total impaired loans with a valuation allowance
10,014

 
248


10,550


215

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
4,304

 
119

 
3,636

 
74

Commercial other
2,608

 
47

 
2,861

 
34

Agricultural real estate
7,612

 
146

 
7,465

 
65

Agricultural other
2,821

 
63

 
5,460

 
156

Home equity lines of credit
94

 
5

 
38

 
6

Consumer secured
2

 

 
8

 

Total impaired loans without a valuation allowance
17,441

 
380

 
19,468

 
335

Impaired loans
 
 
 
 
 
 
 
Commercial
8,323

 
218

 
9,460

 
164

Agricultural
13,839

 
301

 
13,939

 
293

Residential real estate
5,291

 
109

 
6,611

 
93

Consumer
2

 

 
8

 

Total impaired loans
$
27,455

 
$
628

 
$
30,018

 
$
550

As a result of line of credit agreements with borrowers, we had committed to advance $331 and $175 in additional funds to be disbursed in connection with impaired loans as of June 30, 2020 and December 31, 2019, respectively.
Troubled Debt Restructurings
A loan modification is considered to be a TDR when the modification includes terms outside of normal lending practices to a borrower who is experiencing financial difficulties.
Typical concessions granted include, but are not limited to:
Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics.
Extending the amortization period beyond typical lending guidelines for loans with similar risk characteristics.
Agreeing to an interest only payment structure and delaying principal payments.
Forgiving principal.
Forgiving accrued interest.
To determine if a borrower is experiencing financial difficulties, factors we consider include:
The borrower is currently in default on any of their debt.
The borrower would likely default on any of their debt if the concession is not granted.
The borrower’s cash flow is insufficient to service all of their debt if the concession is not granted.
The borrower has declared, or is in the process of declaring, bankruptcy.
The borrower is unlikely to continue as a going concern (if the entity is a business).

24


The following is a summary of TDRs granted for the:
 
Three Months Ended June 30
 
2020
 
2019

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

 
$

 
$

 
1

 
$
37

 
$
37

Agricultural other
2

 
1,768

 
1,768

 
1

 
1,311

 
1,311

Total
2

 
$
1,768

 
$
1,768

 
2

 
$
1,348

 
$
1,348

 
Six Months Ended June 30
 
2020
 
2019

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

 
$
963

 
$
963

 
2

 
$
184

 
$
184

Agricultural other
4

 
2,361

 
2,361

 
3

 
1,834

 
1,834

Residential real estate
2

 
93

 
93

 

 

 

Total
8

 
$
3,417

 
$
3,417

 
5

 
$
2,018

 
$
2,018

The following is a summary of concessions we granted to borrowers in financial difficulty for the:
 
Three Months Ended June 30
 
2020
 
2019

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

 
$

 

 
$

 

 
$

 
1

 
$
37

Agricultural other

 

 
2

 
1,768

 

 

 
1

 
1,311

Total

 
$

 
2

 
$
1,768

 

 
$

 
2

 
$
1,348


Six Months Ended June 30

2020
 
2019

Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
Commercial other
1

 
$
919

 
1

 
$
44

 

 
$

 
2

 
$
184

Agricultural other

 

 
4

 
2,361

 

 

 
3

 
1,834

Residential real estate

 

 
2

 
93

 

 

 

 

Total
1

 
$
919

 
7

 
$
2,498

 

 
$

 
5

 
$
2,018

We did not restructure any loans by forgiving principal or accrued interest in the three and six-month periods ended June 30, 2020 or 2019.
Based on our historical loss experience, losses associated with TDRs are not significantly different than other impaired loans within the same loan segment. As such, TDRs, including TDRs that have been modified in the past 12 months that subsequently defaulted, are analyzed in the same manner as other impaired loans within their respective loan segment.
We had no loans that defaulted in the three and six-month periods ended June 30, 2020 and June 30, 2019 which were modified within 12 months prior to the default date.

25


The following is a summary of TDR loan balances as of:
 
June 30
2020
 
December 31
2019
TDRs
$
23,185

 
$
24,737

Measures we have taken to assist our customers in connection with the COVID-19 pandemic include loan programs that provide short-term payment relief.  Under these programs, borrowers whose loans were in good standing as of March 1, 2020 could elect to defer full or partial payments for a period not to exceed 180 days. Bank regulators issued a statement on March 22, 2020, and a revised statement on April 7, 2020, which provides confirmation that short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers with a current payment status are not categorized as TDRs.
Note 5 – Borrowed Funds
Borrowed funds consist of the following obligations as of:
 
June 30, 2020
 
December 31, 2019

Amount
 
Rate
 
Amount
 
Rate
FHLB advances
$
205,000

 
2.25
%
 
$
245,000

 
2.32
%
Securities sold under agreements to repurchase without stated maturity dates
31,268

 
0.09
%
 
30,999

 
0.09
%
Total
$
236,268

 
1.96
%
 
$
275,999

 
2.07
%
FHLB advances are collateralized by a blanket lien on all qualified 1-4 family residential real estate loans, specific AFS securities, and FHLB stock.
The following table lists the maturities and weighted average interest rates of FHLB advances as of:
 
June 30, 2020
 
December 31, 2019

Amount
 
Rate
 
Amount
 
Rate
Fixed rate due 2020
$
15,000

 
1.75
%
 
$
55,000

 
2.18
%
Fixed rate due 2021
50,000

 
1.91
%
 
50,000

 
1.91
%
Variable rate due 2021 (1)
10,000

 
0.69
%
 
10,000

 
2.20
%
Fixed rate due 2022
20,000

 
1.97
%
 
20,000

 
1.97
%
Fixed rate due 2023
45,000

 
2.97
%
 
45,000

 
2.97
%
Fixed rate due 2024
55,000

 
2.68
%
 
55,000

 
2.68
%
Fixed rate due 2026
10,000

 
1.17
%
 
10,000

 
1.17
%
Total
$
205,000

 
2.25
%
 
$
245,000

 
2.32
%
(1) 
Hedged advance (see “Derivative Instruments” section below)
Securities sold under agreements to repurchase are classified as secured borrowings and are reflected at the amount of cash received in connection with the transaction. The securities underlying the agreements have a carrying value and a fair value of $31,291 and $31,020 at June 30, 2020 and December 31, 2019, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.
Securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances generally mature within one to four days from the transaction date. We had no FRB Discount Window advances during the three and six-month periods ended June 30, 2020 and June 30, 2019.

26


A summary of securities sold under repurchase agreements without stated maturity dates and federal funds purchased was as follows for the:
 
Three Months Ended June 30
 
2020
 
2019
 
Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
 
Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates
$
32,319

 
$
31,036

 
0.10
%
 
$
26,761

 
$
26,569

 
0.09
%
Federal funds purchased
$

 
$

 
%
 
$
7,070

 
$
1,982

 
2.65
%
 
Six Months Ended June 30
 
2020
 
2019
 
Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
 
Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates
$
32,319

 
$
30,980

 
0.10
%
 
$
37,441

 
$
30,755

 
0.04
%
Federal funds purchased
$

 
$

 
%
 
$
7,070

 
$
1,224

 
1.71
%
We had pledged AFS securities and 1-4 family residential real estate loans in the following amounts at:

June 30
2020
 
December 31
2019
Pledged to secure borrowed funds
$
344,529

 
$
368,310

Pledged to secure repurchase agreements
31,291

 
31,020

Pledged for public deposits and for other purposes necessary or required by law
41,497

 
59,537

Total
$
417,317

 
$
458,867

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

June 30
2020
 
December 31
2019
States and political subdivisions
$
14,173

 
$
31,020

Mortgage-backed securities
9,852

 

Collateralized mortgage obligations
7,266

 

Total
$
31,291

 
$
31,020

AFS securities pledged to repurchase agreements are monitored to ensure the appropriate level is collateralized. In the event of maturities, calls, significant principal repayments, or significant decline in market values, we have an adequate level of AFS securities to pledge to satisfy collateral requirements.
As of June 30, 2020, we had the ability to borrow up to an additional $144,495, based on assets pledged as collateral. We had no investment securities that were restricted from being pledged for specific purposes.
Derivative Instruments
We use interest rate swaps to manage exposure to interest rate risk and variability in cash flows. The interest rate swaps, associated with our variable rate borrowings, are designated upon inception as cash flow hedges of forecasted interest payments. We have entered into LIBOR-based interest rate swaps that involve the receipt of variable amounts in exchange for fixed rate payments, in effect converting variable rate debt to fixed rate debt.
Cash flow hedges are assessed for effectiveness using regression analysis. The effective portion of changes in fair value are recorded in OCI and subsequently reclassified into interest expense in the same period in which the related interest on the variable rate borrowings affects earnings. In the event that a portion of the changes in fair value were determined to be ineffective, the ineffective amount would be recorded in earnings.

27


The following tables provide information on derivatives related to variable rate borrowings as of:
 
June 30, 2020

Pay Rate
 
Receive Rate
 
Remaining Life (Years)
 
Notional Amount
 
Balance Sheet Location
 
Fair Value
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Cash Flow Hedges:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
1.56
%
 
3-Month LIBOR
 
0.8
 
$
10,000

 
Other liabilities
 
$
(98
)
 
December 31, 2019
 
Pay Rate
 
Receive Rate
 
Remaining Life (Years)
 
Notional Amount
 
Balance Sheet Location
 
Fair Value
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Cash Flow Hedges:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
1.56
%
 
3-Month LIBOR
 
1.3
 
$
10,000

 
Other assets
 
$
67

Derivatives contain an element of credit risk which arises from the possibility that we will incur a loss as a result of a counterparty failing to meet its contractual obligations. Credit risk is minimized through counterparty collateral, transaction limits and monitoring procedures. We also manage dealer credit risk by entering into interest rate derivatives only with primary and highly rated counterparties, the use of ISDA master agreements, and the use of counterparty limits. We do not anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.
Note 6 – Computation of Earnings Per Common Share
Basic earnings per common share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued relate solely to outstanding shares in the Directors Plan.
Earnings per common share have been computed based on the following for the:
 
Three Months Ended 
 June 30
 
Six Months Ended 
 June 30

2020
 
2019
 
2020
 
2019
Average number of common shares outstanding for basic calculation
7,924,318

 
7,910,512

 
7,927,298

 
7,895,610

Average potential effect of common shares in the Directors Plan (1)
144,430

 
179,364

 
154,177

 
189,355

Average number of common shares outstanding used to calculate diluted earnings per common share
8,068,748

 
8,089,876

 
8,081,475

 
8,084,965

Net income
$
4,187

 
$
4,188

 
$
7,251

 
$
7,684

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.53

 
$
0.53

 
$
0.91

 
$
0.97

Diluted
$
0.52

 
$
0.52

 
$
0.90

 
$
0.95

(1) 
Exclusive of shares held in the Rabbi Trust

28


Note 7 – Restricted Stock Plan
On June 24, 2020 we adopted the RSP, an equity-based bonus plan. The primary purpose of the plan is to promote our growth and profitability by attracting and retaining executive officers and key employees of outstanding competence through ownership of equity that provides them with incentives to achieve corporate objectives. In connection with the adoption of the RSP, the Isabella Bank Corporation Stock Award Incentive Plan was terminated.
Under the RSP, we may award restricted stock bonuses to eligible employees on an annual basis that are not fully transferable or vested until certain conditions are met. Currently, the eligible employees are the Corporation's President and CEO, CFO and the Bank's President. The RSP authorizes the issuance of unvested restricted stock to an eligible employee with a maximum award ranging from 25% to 40% of the employee’s annual salary, on a calendar year basis. The employee must also satisfy the annual performance targets and measures established by the Board of Directors. If these grant conditions are not satisfied, then the award of restricted shares will lapse or be adjusted appropriately, at the discretion of the Board of Directors.
Also on June 24, 2020, we made initial grants under the RSP to eligible employees listed above. All Grant Agreements contain vesting conditions and clawback provisions. As of June 30, 2020, we did not believe the achievement of the targets specified in an award pursuant to the RSP to be probable and therefore, did not recognize any compensation expense pursuant to the RSP.
Note 8 – Other Noninterest Expenses
A summary of expenses included in other noninterest expenses is as follows for the:

Three Months Ended 
 June 30
 
Six Months Ended 
 June 30
 
2020
 
2019
 
2020
 
2019
Audit, consulting, and legal fees
$
498

 
$
453

 
$
931

 
$
906

ATM and debit card fees
328

 
298

 
651

 
546

Marketing costs
265

 
171

 
468

 
313

Donations and community relations
105

 
190

 
435

 
330

Loan underwriting fees
212

 
168

 
378

 
484

Director fees
177

 
190

 
359

 
397

Memberships and subscriptions
159

 
176

 
358

 
343

FDIC insurance premiums
144

 
162

 
300

 
332

Postage and freight
121

 
121

 
252

 
250

All other
555

 
620

 
1,180

 
1,291

Total other noninterest expenses
$
2,564

 
$
2,549

 
$
5,312

 
$
5,192

Note 9 – Federal Income Taxes
The reconciliation of the provision for federal income taxes and the amount computed at the federal statutory tax rate of income before federal income tax expense is as follows for the:

Three Months Ended 
 June 30
 
Six Months Ended 
 June 30
 
2020
 
2019
 
2020
 
2019
Income taxes at statutory rate
$
997

 
$
994

 
$
1,683

 
$
1,801

Effect of nontaxable income
 
 
 
 
 
 
 
Interest income on tax exempt municipal securities
(191
)
 
(236
)
 
(394
)
 
(480
)
Earnings on corporate owned life insurance policies
(113
)
 
(43
)
 
(261
)
 
(79
)
Other
(4
)
 
(4
)
 
(8
)
 
(8
)
Total effect of nontaxable income
(308
)
 
(283
)
 
(663
)
 
(567
)
Effect of nondeductible expenses
3

 
7

 
7

 
13

Effect of tax credits
(134
)
 
(177
)
 
(266
)
 
(357
)
Federal income tax expense
$
558

 
$
541

 
$
761

 
$
890


29


Note 10 – Accumulated Other Comprehensive Income
The following table summarizes the changes in AOCI by component for the:
 
Three Months Ended June 30
 
2020
 
2019

Unrealized
Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
 
Unrealized
Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
Balance, April 1
$
9,459

 
$
(54
)
 
$
(2,695
)
 
$
6,710

 
$
(441
)
 
$
192

 
$
(2,741
)
 
$
(2,990
)
OCI before reclassifications
2,059

 
(29
)
 

 
2,030

 
4,876

 
(127
)
 

 
4,749

Tax effect
(379
)
 
6

 

 
(373
)
 
(1,018
)
 
26

 

 
(992
)
OCI, net of tax
1,680

 
(23
)
 

 
1,657

 
3,858

 
(101
)
 

 
3,757

Balance,
June 30
$
11,139

 
$
(77
)
 
$
(2,695
)
 
$
8,367

 
$
3,417

 
$
91

 
$
(2,741
)
 
$
767

 
Six Months Ended June 30
 
2020
 
2019

Unrealized
Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
 
Unrealized
Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
Balance, January 1
$
4,612

 
$
54

 
$
(2,695
)
 
$
1,971

 
$
(5,200
)
 
$
256

 
$
(2,741
)
 
$
(7,685
)
OCI before reclassifications
8,370

 
(165
)
 

 
8,205

 
10,830

 
(208
)
 

 
10,622

Amounts reclassified from AOCI
(71
)
 

 

 
(71
)
 

 

 

 

Subtotal
8,299

 
(165
)
 

 
8,134

 
10,830

 
(208
)
 

 
10,622

Tax effect
(1,772
)
 
34

 

 
(1,738
)
 
(2,213
)
 
43

 

 
(2,170
)
OCI, net of tax
6,527

 
(131
)
 

 
6,396

 
8,617

 
(165
)



8,452

Balance,
June 30
$
11,139

 
$
(77
)
 
$
(2,695
)
 
$
8,367

 
$
3,417

 
$
91

 
$
(2,741
)
 
$
767

Included in OCI for the three and six-month periods ended June 30, 2020 and June 30, 2019 are changes in unrealized gains and losses related to auction rate money market preferred stocks. These investments, for federal income tax purposes, have no deferred federal income taxes related to unrealized gains or losses given the nature of the investments.
A summary of the components of unrealized gains on AFS securities included in OCI follows for the:
 
Three Months Ended June 30
 
2020
 
2019

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

 
$
1,806

 
$
2,059

 
$
30

 
$
4,846

 
$
4,876

Tax effect

 
(379
)
 
(379
)
 

 
(1,018
)
 
(1,018
)
Unrealized gains (losses), net of tax
$
253

 
$
1,427

 
$
1,680

 
$
30

 
$
3,828

 
$
3,858


30


 
Six Months Ended June 30
 
2020
 
2019

Auction Rate Money Market Preferred Stocks
 
All Other AFS Securities
 
Total
 
Auction Rate Money Market Preferred Stocks
 
All Other AFS Securities
 
Total
Unrealized gains (losses) arising during the period
$
(140
)
 
$
8,510

 
$
8,370

 
$
295

 
$
10,535

 
$
10,830

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

 
(71
)
 
(71
)
 

 

 

Net unrealized gains (losses)
(140
)
 
8,439

 
8,299

 
295

 
10,535

 
10,830

Tax effect

 
(1,772
)
 
(1,772
)
 

 
(2,213
)
 
(2,213
)
Unrealized gains (losses), net of tax
$
(140
)
 
$
6,667

 
$
6,527

 
$
295


$
8,322


$
8,617

Note 11 – Fair Value
Under fair value measurement and disclosure authoritative guidance, we group assets and liabilities measured at fair value into three levels, based on the markets in which the assets and liabilities are traded, and the reliability of the assumptions used to determine fair value, based on the prioritization of inputs in the valuation techniques. These levels are:
Level 1:
Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2:
Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3:
Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.
The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. Transfers between measurement levels are recognized at the end of reporting periods.
Fair value measurement requires the use of an exit price notion which may differ from entrance pricing. Generally we believe our assets and liabilities classified as Level 1 or Level 2 approximate an exit price notion.
Following is a description of the valuation methodologies, key inputs, and an indication of the level of the fair value hierarchy in which the assets or liabilities are classified.
AFS securities: AFS securities are recorded at fair value on a recurring basis. Level 1 fair value measurement is based upon quoted prices for identical instruments. Level 2 fair value measurement is based upon quoted prices for similar instruments. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions. The values for Level 1 and Level 2 investment securities are generally obtained from an independent third party. On a quarterly basis, we compare the values provided to alternative pricing sources.
Loans: We do not record loans at fair value on a recurring basis. However, some loans are classified as impaired and a specific allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will be significantly different than the contractual terms of the original loan agreement are considered impaired. Once a loan is identified as impaired, we measure the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral, less costs to sell, if the loan is collateral dependent. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.

31


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:

June 30, 2020
Valuation Technique
Fair Value
Unobservable Input
 
Actual Range
Weighted Average
 
 
Discount applied to collateral:
 
 
 
 
 
Real Estate
 
20% - 30%
22%
 
 
Equipment
 
20% - 40%
30%
Discounted value
$18,073
Cash crop inventory
 
40%
40%
 
 
Livestock
 
30%
30%
 
 
Other inventory
 
50%
50%
 
 
Accounts receivable
 
25% - 50%
25%

December 31, 2019
Valuation Technique
Fair Value
Unobservable Input
 
Actual Range
Weighted Average
 
 
Discount applied to collateral:
 
 
 
 
 
Real Estate
 
20% - 30%
22%
 
 
Equipment
 
20% - 40%
32%
Discounted value
$19,135
Cash crop inventory
 
40%
40%
 
 
Livestock
 
30%
30%
 
 
Other inventory
 
50%
50%
 
 
Accounts receivable
 
25% - 50%
28%
Collateral discount rates may have ranges to accommodate differences in the age of the independent appraisal, broker price opinion, or internal evaluation.
Derivative instruments: Derivative instruments, consisting solely of interest rate swaps, are recorded at fair value on a recurring basis. Derivatives qualifying as cash flow hedges, when highly effective, are reported at fair value in other assets or other liabilities on our Consolidated Balance Sheets with changes in value recorded in OCI. Should the hedge no longer be considered effective, the ineffective portion of the change in fair value is recorded directly in earnings in the period in which the change occurs. The fair value of a derivative is determined by quoted market prices and model-based valuation techniques. As such, we classify derivative instruments as Level 2.
OMSR: OMSR (which are included in other assets) are subject to impairment testing. To test for impairment, we utilize a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and discount rates. If the valuation model reflects a value less than the carrying value, OMSR are adjusted to fair value through a valuation allowance as determined by the model. As such, we classify OMSR subject to nonrecurring fair value adjustments as Level 2.
The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Although we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement.

32


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:
 
June 30, 2020

Carrying
Value
 
Estimated
Fair Value
 
Level 1
 
Level 2
 
Level 3
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
109,384

 
$
109,384

 
$
109,384

 
$

 
$

Mortgage loans AFS
5,451

 
5,523

 

 
5,523

 

Gross loans
1,284,385

 
1,284,003

 

 

 
1,284,003

Less allowance for loan and lease losses
8,877

 
8,877

 

 

 
8,877

Net loans
1,275,508

 
1,275,126

 

 

 
1,275,126

Accrued interest receivable
7,715

 
7,715

 
7,715

 

 

Equity securities without readily determinable fair values (1)
21,660

 
N/A

 

 

 

OMSR
1,914

 
1,914

 

 
1,914

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
1,062,055

 
1,062,055

 
1,062,055

 

 

Deposits with stated maturities
378,623

 
387,322

 

 
387,322

 

Borrowed funds
236,268

 
245,093

 

 
245,093

 

Accrued interest payable
667

 
667

 
667

 

 

 
December 31, 2019
 
Carrying
Value
 
Estimated
Fair Value
 
Level 1
 
Level 2
 
Level 3
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
60,572

 
$
60,572

 
$
60,572

 
$

 
$

Mortgage loans AFS
904

 
925

 

 
925

 

Gross loans
1,186,570

 
1,170,370

 

 

 
1,170,370

Less allowance for loan and lease losses
7,939

 
7,939

 

 

 
7,939

Net loans
1,178,631

 
1,162,431

 

 

 
1,162,431

Accrued interest receivable
6,501

 
6,501

 
6,501

 

 

Equity securities without readily determinable fair values (1)
21,629

 
N/A

 

 

 

OMSR
2,264

 
2,264

 

 
2,264

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
906,232

 
906,232

 
906,232

 

 

Deposits with stated maturities
407,619

 
409,600

 

 
409,600

 

Borrowed funds
275,999

 
278,761

 

 
278,761

 

Accrued interest payable
860

 
860

 
860

 

 

(1) 
Due to the characteristics of equity securities without readily determinable fair values, they are not disclosed under a specific fair value hierarchy. When an impairment or write-down related to these securities is recorded, such amount would be classified as a nonrecurring Level 3 fair value adjustment.

33


Financial Instruments Recorded at Fair Value
The table below presents the recorded amount of assets and liabilities measured at fair value on:
 
June 30, 2020
 
December 31, 2019

Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
Recurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AFS securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
States and political subdivisions
$
146,785

 
$

 
$
146,785

 
$

 
$
169,752

 
$

 
$
169,752

 
$

Auction rate money market preferred
2,979

 

 
2,979

 

 
3,119

 

 
3,119

 

Mortgage-backed securities
119,029

 

 
119,029

 

 
140,204

 

 
140,204

 

Collateralized mortgage obligations
111,621

 

 
111,621

 

 
116,764

 

 
116,764

 

Total AFS securities
380,414

 

 
380,414

 

 
429,839

 

 
429,839

 

Derivative instruments
98

 

 
98

 

 
67

 

 
67

 

Nonrecurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans (net of the ALLL)
18,073

 

 

 
18,073

 
19,135

 

 

 
19,135

OMSR
1,914

 

 
1,914

 

 
2,264

 

 
2,264

 

Total
$
400,499

 
$

 
$
382,426

 
$
18,073

 
$
451,305

 
$

 
$
432,170

 
$
19,135

Percent of assets and liabilities measured at fair value
 
 
%
 
95.49
%
 
4.51
%
 
 
 
%
 
95.76
%
 
4.24
%
We recorded an impairment related to OMSR of $316 and $44 through earnings for the six-month period ended June 30, 2020 and June 30, 2019, respectively. We had no other assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a recurring basis or nonrecurring basis, as of June 30, 2020. Further, we had no unrealized gains and losses for the period included in OCI for recurring Level 3 fair value measurements held at the end of the reporting period.
Note 12 – Operating Segments
Our reportable segments are based on legal entities that account for at least 10% of net operating results. The Bank as of June 30, 2020 and December 31, 2019 and for the three and six-month periods ended June 30, 2020 and June 30, 2019, represent approximately 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented.
Note 13 – Parent Company Only Financial Information
Interim Condensed Balance Sheets

June 30
2020
 
December 31
2019
ASSETS
 
 
 
Cash on deposit at the Bank
$
176

 
$
1,360

Investments in subsidiaries
168,247

 
157,415

Premises and equipment
1,516

 
1,539

Other assets
50,087

 
49,887

TOTAL ASSETS
$
220,026

 
$
210,201

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Other liabilities
$
35

 
$
19

Shareholders' equity
219,991

 
210,182

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
220,026

 
$
210,201


34


Interim Condensed Statements of Income
 
Three Months Ended 
 June 30
 
Six Months Ended 
 June 30

2020
 
2019
 
2020
 
2019
Income
 
 
 
 
 
 
 
Dividends from subsidiaries
$
1,850

 
$
2,100

 
$
3,600

 
$
3,100

Interest income

 
2

 
1

 
4

Other income (loss)
126

 
232

 
127

 
213

Total income
1,976

 
2,334

 
3,728

 
3,317

Expenses
 
 
 
 
 
 
 
Occupancy and equipment
15

 
14

 
30

 
29

Audit, consulting, and legal fees
175

 
115

 
307

 
245

Director fees
89

 
89

 
183

 
187

Other
310

 
328

 
603

 
618

Total expenses
589

 
546

 
1,123

 
1,079

Income before income tax benefit and equity in undistributed earnings of subsidiaries
1,387

 
1,788

 
2,605

 
2,238

Federal income tax benefit
97

 
64

 
209

 
179

Income before equity in undistributed earnings of subsidiaries
1,484

 
1,852

 
2,814

 
2,417

Undistributed earnings of subsidiaries
2,703

 
2,336

 
4,437

 
5,267

Net income
$
4,187

 
$
4,188

 
$
7,251

 
$
7,684

Interim Condensed Statements of Cash Flows
 
Six Months Ended 
 June 30

2020
 
2019
Operating activities
 
 
 
Net income
$
7,251

 
$
7,684

Adjustments to reconcile net income to cash provided by operations
 
 
 
Undistributed earnings of subsidiaries
(4,437
)
 
(5,267
)
Undistributed earnings of equity securities without readily determinable fair values
(31
)
 
(76
)
Share-based payment awards under equity compensation plan
233

 
271

Depreciation
23

 
23

Changes in operating assets and liabilities which provided (used) cash
 
 
 
Other assets
(168
)
 
5

Other liabilities
16

 
682

Net cash provided by (used in) operating activities
2,887

 
3,322

Investing activities - none
 
 
 
Financing activities
 
 
 
Cash dividends paid on common stock
(4,249
)
 
(4,093
)
Proceeds from the issuance of common stock
2,343

 
2,436

Common stock repurchased
(1,195
)
 
(1,339
)
Common stock purchased for deferred compensation obligations
(970
)
 
(816
)
Net cash provided by (used in) financing activities
(4,071
)
 
(3,812
)
Increase (decrease) in cash and cash equivalents
(1,184
)
 
(490
)
Cash and cash equivalents at beginning of period
1,360

 
2,499

Cash and cash equivalents at end of period
$
176

 
$
2,009


35


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
ISABELLA BANK CORPORATION FINANCIAL REVIEW
(Dollars in thousands except per share amounts)
The following is management's discussion and analysis of our financial condition and results of operations for the unaudited three and six-month periods ended June 30, 2020 and June 30, 2019. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2019 and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 4 of this report.
Executive Summary
During the three and six months ended June 30, 2020, we reported net income of $4,187 and $7,251 and earnings per common share of $0.53 and $0.91, respectively. Net income and earnings per common share for the same periods of 2019 were $4,188 and $7,684 and $0.53 and $0.97, respectively. A decline in the interest rate environment was a large driver of a $1,226 decrease in interest income for the first six months of 2020 compared to the same period in 2019. Interest expense on deposits and borrowings decreased $1,055 for the six-month period ended June 30, 2020 compared to the same period in 2019 primarily due to reduced interest rates and reduced reliance on higher-cost borrowings. Net interest income decreased by $171 for the six-month period ended June 30, 2020 in comparison to the same period in 2019. The provision for loan losses increased by $1,038 for the six-month period ended June 30, 2020 compared to the same period in 2019, as the result of increased economic and environmental risk factors, predominantly driven by COVID-19. Noninterest income increased $754 during the first six months of 2020 compared to the same period in 2019, mainly as a result of gains from the redemption of corporate owned life insurance policies. Noninterest expenses for the first six months of 2020 exceeded the same period in 2019 by $107, primarily due to community relations and donation-related expenses.
As of June 30, 2020, total assets and assets under management were $1,913,227 and $2,571,773, respectively. Assets under management include loans sold and serviced of $263,332 and investment and trust assets managed by Isabella Wealth of $395,214, in addition to assets on our consolidated balance sheet. In 2020, the Bank’s investment and trust services business was re-engineered and rebranded as Isabella Wealth to enhance the client experience, build scalability and expand market awareness.
Our securities portfolio has declined $49,425 since December 31, 2019, predominantly as a result of maturities and sales of AFS securities. Due to the flat yield curve that has existed for over a year, the opportunity to identify new investment securities for purchase at an acceptable yield has been minimal. Loans outstanding as of June 30, 2020 totaled $1,284,385. During the first six months of 2020, gross loans increased $97,815 which was largely driven by SBA PPP loans. Total deposits increased $126,827 during the first six months of 2020, primarily due to increases in interest bearing demand and savings deposits, and totaled $1,440,678 as of June 30, 2020. All regulatory capital ratios for the Bank exceeded the minimum thresholds to be considered a “well capitalized” institution.
Our net yield on interest earning assets (FTE) was 2.92% and 2.95% for the three and six months ended June 30, 2020. This compares to 3.06% and 3.04% for the three and six months ended June 30, 2019. Management has put in place strategic programs focused on improving our net yield on interest earning assets, which includes enhanced pricing related to loans and deposits and a reduced reliance on higher-cost borrowed funds and brokered deposits as funding sources. However, the current interest rate environment has had a negative impact on our net yields on interest earning assets and future improvement may be gradual. We are actively committed to increasing earnings and shareholder value through growth in our loan portfolio while maintaining strong underwriting standards, growth in our wealth management services, increasing our presence within our geographical footprint, and managing operating costs.
Recent Events and Legislation
Restricted Stock Plan: On June 24, 2020 we adopted the RSP, an equity-based bonus plan. Under the RSP, we may award restricted stock bonuses to eligible employees on an annual basis that are not fully transferable or vested until certain conditions are met. The RSP authorizes the issuance of unvested restricted stock to an eligible employee with a maximum award ranging from 25% to 40% of the employee’s annual salary, on a calendar year basis. The employee must also satisfy the annual performance targets and measures established by the Board of Directors. If these grant conditions are not satisfied, then the award of restricted shares will lapse or be adjusted appropriately, at the discretion of the Board of Directors. In connection with the adoption of the RSP, the Isabella Bank Corporation Stock Award Incentive Plan was terminated.
Also on June 24, 2020, we made initial grants under the RSP to the Corporation's President and CEO, CFO and the Bank's President. All Grant Agreements contain vesting conditions and clawback provisions. As of June 30, 2020, we did not believe

36


the achievement of the targets specified in an award pursuant to the RSP to be probable and therefore, did not recognize any compensation expense pursuant to the RSP.
Impact of COVID-19: Unexpected and unprecedented changes have occurred during the year as the result of COVID-19.  This aggressive and persistent virus causes a respiratory disease that currently has no approved vaccine or antiviral treatment and can result in serious illness or death.  The World Health Organization has declared the situation a global pandemic.
The pandemic has created significant market volatility, economic uncertainty, and disruption to normal business operations around the world, with slowdowns and shutdowns affecting entire industries.  The Michigan governor issued on March 23, 2020 a stay-at-home order, which limited gatherings and travel, and required those in select businesses who were not deemed essential to sustain or protect life to stay home.  The Michigan stay-at-home order was in effect until early June.  The orders, as the result of COVID-19, led to financial stress for many businesses and their employees throughout the communities we serve.
The CARES Act, a massive and unprecedented federal government support program, was enacted on March 27, 2020.  It is a $2 trillion stimulus package intended to provide financial relief across the country.  The CARES Act includes the PPP, which enables businesses to obtain a forgivable SBA loan to meet payroll, rent, utility, and mortgage interest obligations for the 24-week period following the loan origination, and re-open quickly once the public health crisis ends. The first applications for PPP funds, with a term of two years, were accepted April 3, 2020.  We are proud to facilitate SBA PPP loans to businesses throughout the communities in which we serve. As of June 30, 2020, we funded more than 950 SBA PPP loans for a total of $99,450.
Bank regulators issued an interim rule that neutralizes the regulatory capital effects by allowing a zero percent risk weight, for capital purposes, to loans originated under the PPP.  The capital rule was issued April 9, 2020, with an immediate effective date.   
Many of our customers have expressed their general concern about the uncertain economic conditions, but it is premature to reasonably predict the magnitude of the impact. One measure we have taken to assist our customers include loan programs that provide short-term payment relief.  Under these programs, borrowers whose loans were in good standing as of March 1, 2020 could elect to defer full or partial payments for a period not to exceed 180 days.  Bank regulators issued a statement on March 22, 2020, and a revised statement on April 7, 2020, which provides confirmation that short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers with a current payment status are not categorized as TDRs. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.
The extent to which COVID-19 impacts our business will depend on future developments, which are highly uncertain and cannot be predicted with any accuracy. Future developments include new information which may emerge concerning the severity of COVID-19 and the actions to contain the coronavirus or treat its impact, among others. We expect the significance of the COVID-19 pandemic, including the extent of its effect on our financial and operational results, to be dictated by, among other factors, its duration, the success of efforts to contain it and the impact of actions taken in response. Uncertainty created by the COVID-19 pandemic is pervasive, and the pandemic has impacted our operations, customers, and various areas of risk. With the uncertainty created by COVID-19, it's challenging to determine the full impact of the COVID-19 pandemic on our ongoing financial and operational results.
Reclassifications
Certain amounts reported in the interim 2019 consolidated financial statements have been reclassified to conform to the 2020 presentation.
Subsequent Events
We evaluated subsequent events after June 30, 2020 through the date our consolidated financial statements were issued for potential recognition and disclosure. No subsequent events require financial statement recognition or disclosure between June 30, 2020 and the date our consolidated financial statements were issued.

37


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

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
Interest income
$
15,869

 
$
16,201

 
$
16,849

 
$
17,161

 
$
16,815

Interest expense
3,565

 
4,199

 
4,492

 
4,550

 
4,527

Net interest income
12,304

 
12,002

 
12,357

 
12,611

 
12,288

Provision for loan losses
105

 
788

 
(18
)
 
193

 
(179
)
Noninterest income
3,246

 
2,998

 
(725
)
 
3,274

 
3,011

Noninterest expenses
10,700

 
10,945

 
10,892

 
10,620

 
10,749

Federal income tax expense (benefit)
558

 
203

 
(140
)
 
630

 
541

Net income
$
4,187

 
$
3,064

 
$
898

 
$
4,442

 
$
4,188

PER SHARE
 
 
 
 
 
 
 
 
 
Basic earnings
$
0.53

 
$
0.39

 
$
0.12

 
$
0.56

 
$
0.53

Diluted earnings
$
0.52

 
$
0.38

 
$
0.11

 
$
0.55

 
$
0.52

Dividends
$
0.27

 
$
0.27

 
$
0.27

 
$
0.26

 
$
0.26

Tangible book value
$
21.52

 
$
21.10

 
$
20.45

 
$
20.66

 
$
20.17

Quoted market value
 
 
 
 
 
 
 
 
 
High
$
19.50

 
$
24.50

 
$
24.80

 
$
23.45

 
$
23.75

Low
$
15.60

 
$
16.00

 
$
22.25

 
$
22.01

 
$
22.25

Close (1)
$
18.25

 
$
18.00

 
$
24.31

 
$
22.30

 
$
23.25

Common shares outstanding (1)
7,977,019

 
7,921,291

 
7,910,804

 
7,938,234

 
7,918,494

PERFORMANCE RATIOS
 
 
 
 
 
 
 
 
 
Return on average total assets
0.89
%
 
0.68
%
 
0.20
%
 
0.98
%
 
0.93
%
Return on average shareholders' equity
7.63
%
 
5.68
%
 
1.66
%
 
8.37
%
 
8.13
%
Return on average tangible shareholders' equity
9.81
%
 
7.35
%
 
2.18
%
 
10.87
%
 
10.67
%
Net interest margin yield (FTE)
2.92
%
 
2.98
%
 
3.06
%
 
3.13
%
 
3.06
%
BALANCE SHEET DATA (1)
 
 
 
 
 
 
 
 
 
Gross loans
$
1,284,385

 
$
1,175,936

 
$
1,186,570

 
$
1,191,804

 
$
1,176,622

AFS securities
$
380,414

 
$
407,189

 
$
429,839

 
$
445,529

 
$
470,449

Total assets
$
1,913,227

 
$
1,815,904

 
$
1,814,198

 
$
1,813,684

 
$
1,824,592

Deposits
$
1,440,678

 
$
1,322,083

 
$
1,313,851

 
$
1,308,773

 
$
1,281,418

Borrowed funds
$
236,268

 
$
263,171

 
$
275,999

 
$
277,386

 
$
320,462

Shareholders' equity
$
219,991

 
$
215,498

 
$
210,182

 
$
212,376

 
$
208,114

Gross loans to deposits
89.15
%
 
88.95
%
 
90.31
%
 
91.06
%
 
91.82
%
ASSETS UNDER MANAGEMENT (1)
 
 
 
 
 
 
 
 
 
Loans sold with servicing retained
$
263,332

 
$
257,285

 
$
259,375

 
$
258,873

 
$
257,062

Assets managed by Isabella Wealth
$
395,214

 
$
359,968

 
$
436,181

 
$
475,574

 
$
487,180

Total assets under management
$
2,571,773

 
$
2,433,157

 
$
2,509,754

 
$
2,548,131

 
$
2,568,834

ASSET QUALITY (1)
 
 
 
 
 
 
 
 
 
Nonperforming loans to gross loans
0.42
%
 
0.59
%
 
0.55
%
 
0.59
%
 
0.70
%
Nonperforming assets to total assets
0.33
%
 
0.43
%
 
0.40
%
 
0.42
%
 
0.49
%
ALLL to gross loans
0.69
%
 
0.74
%
 
0.67
%
 
0.69
%
 
0.68
%
CAPITAL RATIOS (1)
 
 
 
 
 
 
 
 
 
Shareholders' equity to assets
11.50
%
 
11.87
%
 
11.59
%
 
11.71
%
 
11.41
%
Tier 1 leverage
8.86
%
 
9.09
%
 
9.01
%
 
9.16
%
 
9.03
%
Common equity tier 1 capital
12.90
%
 
12.72
%
 
12.56
%
 
12.58
%
 
12.43
%
Tier 1 risk-based capital
12.90
%
 
12.72
%
 
12.56
%
 
12.58
%
 
12.43
%
Total risk-based capital
13.60
%
 
13.41
%
 
13.18
%
 
13.21
%
 
13.06
%
(1) At end of period

38


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

June 30
2020
 
June 30
2019
 
June 30
2018
INCOME STATEMENT DATA
 
 
 
 
 
Interest income
$
32,070

 
$
33,296

 
$
30,834

Interest expense
7,764

 
8,819

 
7,142

Net interest income
24,306

 
24,477

 
23,692

Provision for loan losses
893

 
(145
)
 
712

Noninterest income
6,244

 
5,490

 
5,238

Noninterest expenses
21,645

 
21,538

 
20,895

Federal income tax expense (benefit)
761

 
890

 
528

Net income
$
7,251

 
$
7,684


$
6,795

PER SHARE
 
 
 
 
 
Basic earnings
$
0.91

 
$
0.97

 
$
0.86

Diluted earnings
$
0.90

 
$
0.95

 
$
0.84

Dividends
$
0.54

 
$
0.52

 
$
0.52

Tangible book value
$
21.52

 
$
20.17

 
$
18.09

Quoted market value
 
 
 
 
 
High
$
24.50

 
$
24.50

 
$
28.25

Low
$
15.60

 
$
22.25

 
$
26.11

Close (1)
$
18.25

 
$
23.25

 
$
26.65

Common shares outstanding (1)
7,977,019

 
7,918,494

 
7,933,250

PERFORMANCE RATIOS
 
 
 
 
 
Return on average total assets
0.78
%
 
0.85
%
 
0.75
%
Return on average shareholders' equity
6.67
%
 
7.58
%
 
7.00
%
Return on average tangible shareholders' equity
4.30
%
 
9.73
%
 
8.92
%
Net interest margin yield (FTE)
2.95
%
 
3.04
%
 
2.95
%
BALANCE SHEET DATA (1)
 
 
 
 
 
Gross loans
$
1,284,385

 
$
1,176,622

 
$
1,151,756

AFS securities
$
380,414

 
$
470,449

 
$
524,108

Total assets
$
1,913,227

 
$
1,824,592

 
$
1,836,955

Deposits
$
1,440,678

 
$
1,281,418

 
$
1,274,762

Borrowed funds
$
236,268

 
$
320,462

 
$
362,496

Shareholders' equity
$
219,991

 
$
208,114

 
$
191,949

Gross loans to deposits
89.15
%
 
91.82
%
 
90.35
%
ASSETS UNDER MANAGEMENT (1)
 
 
 
 
 
Loans sold with servicing retained
$
263,332

 
$
257,062

 
$
257,865

Assets managed by Isabella Wealth
$
395,214

 
$
487,180

 
$
494,533

Total assets under management
$
2,571,773

 
$
2,568,834

 
$
2,589,353

ASSET QUALITY (1)
 
 
 
 
 
Nonperforming loans to gross loans
0.42
%
 
0.70
%
 
0.58
%
Nonperforming assets to total assets
0.33
%
 
0.49
%
 
0.38
%
ALLL to gross loans
0.69
%
 
0.68
%
 
0.71
%
CAPITAL RATIOS (1)
 
 
 
 
 
Shareholders' equity to assets
11.50
%
 
11.41
%
 
10.45
%
Tier 1 leverage
8.86
%
 
9.03
%
 
8.71
%
Common equity tier 1 capital
12.90
%
 
12.43
%
 
12.11
%
Tier 1 risk-based capital
12.90
%
 
12.43
%
 
12.11
%
Total risk-based capital
13.60
%
 
13.06
%
 
12.76
%
(1) At end of period

39


Average Balances, Interest Rates, and Net Interest Income
The following schedules present the daily average amount outstanding for each major category of interest earning assets, non-earning assets, interest bearing liabilities, and noninterest bearing liabilities. These schedules also present an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a FTE basis using a federal income tax rate of 21%. Loans in nonaccrual status, for the purpose of the following computations, are included in the average loan balances. FRB and FHLB restricted equity holdings are included in other interest earning assets.

Three Months Ended

June 30, 2020

March 31, 2020

June 30, 2019

Average
Balance

Tax
Equivalent
Interest

Average
Yield /
Rate

Average
Balance

Tax
Equivalent
Interest

Average
Yield /
Rate

Average
Balance

Tax
Equivalent
Interest

Average
Yield /
Rate
INTEREST EARNING ASSETS

















Loans
$
1,241,856


$
13,297


4.28
%

$
1,168,070


$
13,254


4.54
%

$
1,155,284


$
13,587


4.70
%
Taxable investment securities
237,769


1,352


2.27
%

251,797


1,489


2.37
%

309,650


1,873


2.42
%
Nontaxable investment securities
141,229


1,333


3.78
%

152,368


1,418


3.72
%

172,400


1,623


3.77
%
Fed funds sold
12

 

 
0.04
%
 

 

 
%
 

 

 
%
Other
111,702


234


0.84
%

90,297


405


1.79
%

25,123


148


2.36
%
Total earning assets
1,732,568


16,216


3.74
%

1,662,532


16,566


3.99
%

1,662,457


17,231


4.15
%
NONEARNING ASSETS

















Allowance for loan losses
(8,769
)





(7,968
)





(8,349
)




Cash and demand deposits due from banks
20,389






21,556






19,089





Premises and equipment
25,854






26,252






27,326





Accrued income and other assets
120,444






110,786






107,046





Total assets
$
1,890,486






$
1,813,158






$
1,807,569





INTEREST BEARING LIABILITIES

















Interest bearing demand deposits
$
249,735


$
86


0.14
%

$
235,161


$
83


0.14
%

$
230,238


$
83


0.14
%
Savings deposits
447,416


257


0.23
%

426,634


634


0.59
%

374,750


586


0.63
%
Time deposits
387,636


1,904


1.96
%

404,717


2,074


2.05
%

430,098


2,196


2.04
%
Borrowed funds
253,838


1,318


2.08
%

270,648


1,408


2.08
%

321,958


1,662


2.06
%
Total interest bearing liabilities
1,338,625


3,565


1.07
%

1,337,160


4,199


1.26
%

1,357,044


4,527


1.33
%
NONINTEREST BEARING LIABILITIES

















Demand deposits
317,035






246,262






230,203





Other
15,355






14,130






14,288





Shareholders’ equity
219,471






215,606






206,034





Total liabilities and shareholders’ equity
$
1,890,486






$
1,813,158






$
1,807,569





Net interest income (FTE)


$
12,651






$
12,367






$
12,704



Net yield on interest earning assets (FTE)




2.92
%





2.98
%





3.06
%

40


 
Six Months Ended
 
June 30, 2020
 
June 30, 2019

Average
Balance
 
Tax
Equivalent
Interest
 
Average
Yield /
Rate
 
Average
Balance
 
Tax
Equivalent
Interest
 
Average
Yield /
Rate
INTEREST EARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
Loans
$
1,204,961

 
$
26,551

 
4.41
%
 
$
1,143,255

 
$
26,478

 
4.63
%
Taxable investment securities (1)
244,783

 
2,841

 
2.32
%
 
314,778

 
3,831

 
2.43
%
Nontaxable investment securities
146,799

 
2,751

 
3.75
%
 
176,123

 
3,310

 
3.76
%
Fed funds sold
6

 

 
0.07
%
 
13

 

 
2.39
%
Other
101,000

 
639

 
1.27
%
 
32,923

 
527

 
3.20
%
Total earning assets
1,697,549

 
32,782

 
3.86
%
 
1,667,092

 
34,146

 
4.10
%
NONEARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses
(8,368
)
 
 
 
 
 
(8,378
)
 
 
 
 
Cash and demand deposits due from banks
20,972

 
 
 
 
 
19,140

 
 
 
 
Premises and equipment
26,052

 
 
 
 
 
27,517

 
 
 
 
Accrued income and other assets
115,615

 
 
 
 
 
103,473

 
 
 
 
Total assets
$
1,851,820

 
 
 
 
 
$
1,808,844

 
 
 
 
INTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
$
242,448

 
$
169

 
0.14
%
 
$
233,139

 
$
151

 
0.13
%
Savings deposits
437,025

 
891

 
0.41
%
 
377,926

 
1,201

 
0.64
%
Time deposits
396,178

 
3,978

 
2.01
%
 
433,255

 
4,231

 
1.95
%
Borrowed funds
262,244

 
2,726

 
2.08
%
 
321,703

 
3,236

 
2.01
%
Total interest bearing liabilities
1,337,895

 
7,764

 
1.16
%
 
1,366,023

 
8,819

 
1.29
%
NONINTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
281,638

 
 
 
 
 
228,382

 
 
 
 
Other
14,747

 
 
 
 
 
11,594

 
 
 
 
Shareholders’ equity
217,540

 
 
 
 
 
202,845

 
 
 
 
Total liabilities and shareholders’ equity
$
1,851,820

 
 
 
 
 
$
1,808,844

 
 
 
 
Net interest income (FTE)
 
 
$
25,018

 
 
 
 
 
$
25,327

 
 
Net yield on interest earning assets (FTE)
 
 
 
 
2.95
%
 
 
 
 
 
3.04
%
Net interest income is the amount by which interest income on earning assets exceeds the interest expense on interest bearing liabilities. Net interest income is influenced by changes in the balance and mix of assets and liabilities, as well as market interest rates. We exert some control over these factors; however, FRB monetary policy and competition have a significant impact. For analytical purposes, net interest income is adjusted to an FTE basis by including the income tax savings from interest on tax exempt loans and nontaxable investment securities, thus making year to year comparisons more meaningful.

41


Volume and Rate Variance Analysis
The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. Changes in interest due to volume and rate were determined as follows:
Volume—change in volume multiplied by the previous period's rate.
Rate—change in the FTE rate multiplied by the previous period's volume.
The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
 
Three Months Ended 
 June 30, 2020 Compared to 
 March 31, 2020 
 Increase (Decrease) Due to
 
Three Months Ended 
 June 30, 2020 Compared to  
 June 30, 2019 
  Increase (Decrease) Due to
 
Six Months Ended 
 June 30, 2020 Compared to 
 June 30, 2019 
 Increase (Decrease) Due to

Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Changes in interest income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans
$
812

 
$
(769
)
 
$
43

 
$
976

 
$
(1,266
)
 
$
(290
)
 
$
1,393

 
$
(1,320
)
 
$
73

Taxable investment securities
(81
)
 
(56
)
 
(137
)
 
(414
)
 
(107
)
 
(521
)
 
(819
)
 
(171
)
 
(990
)
Nontaxable investment securities
(105
)
 
20

 
(85
)
 
(294
)
 
4

 
(290
)
 
(550
)
 
(9
)
 
(559
)
Other
80

 
(251
)
 
(171
)
 
233

 
(147
)
 
86

 
580

 
(468
)
 
112

Total changes in interest income
706

 
(1,056
)
 
(350
)
 
501

 
(1,516
)
 
(1,015
)
 
604

 
(1,968
)
 
(1,364
)
Changes in interest expense
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
5

 
(2
)
 
3

 
7

 
(4
)
 
3

 
6

 
12

 
18

Savings deposits
29

 
(406
)
 
(377
)
 
97

 
(426
)
 
(329
)
 
167

 
(477
)
 
(310
)
Time deposits
(86
)
 
(84
)
 
(170
)
 
(211
)
 
(81
)
 
(292
)
 
(370
)
 
117

 
(253
)
Borrowed funds
(87
)
 
(3
)
 
(90
)
 
(354
)
 
10

 
(344
)
 
(615
)
 
105

 
(510
)
Total changes in interest expense
(139
)
 
(495
)
 
(634
)
 
(461
)
 
(501
)
 
(962
)
 
(812
)
 
(243
)
 
(1,055
)
Net change in interest margin (FTE)
$
845

 
$
(561
)
 
$
284

 
$
962

 
$
(1,015
)
 
$
(53
)
 
$
1,416

 
$
(1,725
)
 
$
(309
)
The flattening of the yield curve and recent rate reductions placed pressure on our net interest margin, and we experienced a decline in our net yield on interest earning assets. Given the uncertainty in rates and the economic environment as a result of COVID-19, improvement in our net yield on interest earning assets may not occur during the remainder of 2020.
 
Average Yield / Rate for the Three-Month Periods Ended:

June 30
2020

March 31
2020

December 31
2019

September 30
2019

June 30
2019
Total earning assets
3.74
%
 
3.99
%
 
4.13
%
 
4.23
%
 
4.15
%
Total interest bearing liabilities
1.07
%
 
1.26
%
 
1.34
%
 
1.35
%
 
1.33
%
Net yield on interest earning assets (FTE)
2.92
%

2.98
%
 
3.06
%
 
3.13
%
 
3.06
%
 
Quarter to Date Net Interest Income (FTE)

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
Total interest income (FTE)
$
16,216

 
$
16,566

 
$
17,245

 
$
17,567

 
$
17,231

Total interest expense
3,565

 
4,199

 
4,492

 
4,550

 
4,527

Net interest income (FTE)
$
12,651

 
$
12,367

 
$
12,753

 
$
13,017

 
$
12,704


42


Allowance for Loan and Lease Losses
The viability of any financial institution is ultimately determined by its management of credit risk. Loans represent our single largest concentration of risk. The ALLL is our estimation of incurred losses within the existing loan portfolio. We allocate the ALLL throughout the loan portfolio based on our assessment of the underlying risks associated with each loan segment. Our assessments include allocations based on specific impairment valuation allowances, historical charge-offs, internally assigned credit risk ratings, and past due and nonaccrual balances. A portion of the ALLL is not allocated to any one loan segment, but is instead a representation of other qualitative risks that reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
The following table summarizes our charge-offs, recoveries, provision for loan losses, and ALLL balances as of, and for the:
 
Three Months Ended 
 June 30
 
Six Months Ended 
 June 30

2020
 
2019
 
2020
 
2019
ALLL at beginning of period
$
8,697

 
$
8,398

 
$
7,939

 
$
8,375

Charge-offs
 
 
 
 
 
 
 
Commercial
1

 
105

 
5

 
113

Agricultural
6

 
59

 
22

 
59

Residential real estate

 
94

 
15

 
96

Consumer
59

 
75

 
182

 
203

Total charge-offs
66

 
333

 
224

 
471

Recoveries
 
 
 
 
 
 
 
Commercial
30

 
22

 
52

 
73

Agricultural
2

 

 
35

 
1

Residential real estate
39

 
91

 
66

 
118

Consumer
70

 
38

 
116

 
86

Total recoveries
141

 
151

 
269

 
278

Net loan charge-offs (recoveries)
(75
)
 
182

 
(45
)
 
193

Provision for loan losses
105

 
(179
)
 
893

 
(145
)
ALLL at end of period
$
8,877

 
$
8,037

 
$
8,877

 
$
8,037

Net loan charge-offs (recoveries) to average loans outstanding
(0.01
)%
 
0.02
%
 
%
 
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:

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
Total charge-offs
$
66

 
$
158

 
$
334

 
$
143

 
$
333

Total recoveries
141

 
128

 
122

 
82

 
151

Net loan charge-offs (recoveries)
(75
)
 
30

 
212

 
61

 
182

Net loan charge-offs (recoveries) to average loans outstanding
(0.01
)%
 
%
 
0.02
 %
 
0.01
%
 
0.02
 %
Provision for loan losses
$
105

 
$
788

 
$
(18
)
 
$
193

 
$
(179
)
Provision for loan losses to average loans outstanding
0.01
 %
 
0.07
%
 
 %
 
0.02
%
 
(0.02
)%
ALLL
$
8,877

 
$
8,697

 
$
7,939

 
$
8,169

 
$
8,037

ALLL as a % of loans at end of period
0.69
 %
 
0.74
%
 
0.67
 %
 
0.69
%
 
0.68
 %
While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong at June 30, 2020. However, the COVID-19 pandemic led to the temporary closure of businesses throughout the communities in which we serve, which also led to increased unemployment. We increased the ALLL during the first quarter as a result of increased economic and environmental risk factors, primarily driven by COVID-19. While these same factors resulted in an increase to

43


the ALLL during the second quarter as well, improvement in credit quality indicators and reserves for loans individually evaluated for impairment offset much of the increase.
The economic impact from the COVID-19 crisis could pose significant credit risk due to the potential inability of consumer and commercial borrowers to make contractual payments. In late March 2020, we implemented payment programs for borrowers to alleviate the financial setback due to the temporary closure of businesses and lost wages. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators. We continue to monitor the economic impact from COVID-19 as it relates to credit risk to ensure the ALLL is appropriate.
The following table illustrates the two main components of the ALLL as of:

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
ALLL
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
950

 
$
1,309

 
$
1,114

 
$
1,333

 
$
1,479

Collectively evaluated for impairment
7,927

 
7,388

 
6,825

 
6,836

 
6,558

Total
$
8,877

 
$
8,697

 
$
7,939

 
$
8,169

 
$
8,037

ALLL to gross loans
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
0.07
%
 
0.11
%
 
0.09
%
 
0.11
%
 
0.13
%
Collectively evaluated for impairment
0.62
%
 
0.63
%
 
0.58
%
 
0.58
%
 
0.55
%
Total
0.69
%
 
0.74
%
 
0.67
%
 
0.69
%
 
0.68
%
While we utilize our best judgment and information available, the ultimate adequacy of the ALLL is dependent upon a variety of factors beyond our control, including the performance of our borrowers, the economy, and changes in interest rates. We closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at an appropriate level.
For further discussion of the allocation of the ALLL, see “Note 4 – Loans and ALLL” of our interim condensed consolidated financial statements.
Loans Past Due and Loans in Nonaccrual Status
Fluctuations in past due and nonaccrual status loans can have a significant impact on the ALLL. To determine the potential impact, and corresponding estimated losses, we analyze our historical loss trends on loans past due greater than 30 days and nonaccrual status loans for indications of additional deterioration.
 
Total Past Due and Nonaccrual Loans

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
Commercial
$
1,986

 
$
6,180

 
$
2,477

 
$
3,175

 
$
2,243

Agricultural
4,455

 
4,870

 
4,285

 
4,800

 
6,672

Residential real estate
384

 
3,426

 
4,572

 
1,999

 
1,690

Consumer
45

 
366

 
71

 
162

 
94

Total
$
6,870

 
$
14,842

 
$
11,405

 
$
10,136

 
$
10,699

Total past due and nonaccrual loans to gross loans
0.53
%
 
1.26
%
 
0.96
%
 
0.85
%
 
0.91
%
The increase in past due and nonaccrual status loans during the first quarter of 2020 was primarily the result of deterioration in credit quality for a small number of commercial loans. This increase was not a result of the economic impact of COVID-19 or any other apparent factor. During the second quarter of 2020, past due and nonaccrual status loans declined in comparison to the recent periods.
We have implemented payment programs for borrowers to alleviate the financial setback due to the temporary closure of businesses and lost wages. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.
A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual status loans by type, is included in “Note 4 – Loans and ALLL” of our interim condensed consolidated financial statements.

44


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 less likely to default. This approach has permitted certain borrowers to accept a payment structure that will allow them to continue making payments in lieu of foreclosure. The modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. The majority of modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed in nonaccrual status may be placed back on accrual status after six months of continued performance and achievement of current payment status.
We restructure debt with borrowers who, due to financial difficulties, are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, allow interest only payment structures, forgive principal, forgive interest, or grant a combination of these modifications. Typically, the modifications are for a period of three years or less. There were no TDRs that were government sponsored as of June 30, 2020 or December 31, 2019.
Losses associated with TDRs, if any, are included in the estimation of the ALLL during the quarter in which a loan is identified as a TDR, and we review the analysis of the ALLL estimation each reporting period thereafter to ensure its continued appropriateness.
The following tables provide roll-forwards of TDRs for the:
 
Three Months Ended June 30, 2020
 
Accruing Interest
 
Nonaccrual
 
Total

Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
April 1, 2020
114

 
$
20,268

 
9

 
$
3,849

 
123

 
$
24,117

New modifications
2

 
1,768

 

 

 
2

 
1,768

Principal advances (payments)

 
(90
)
 

 
(24
)
 

 
(114
)
Loans paid off
(6
)
 
(1,461
)
 
(2
)
 
(850
)
 
(8
)
 
(2,311
)
Transfers to OREO

 

 
(1
)
 
(275
)
 
(1
)
 
(275
)
Transfers to accrual status
1

 
104

 
(1
)
 
(104
)
 

 

June 30, 2020
111

 
$
20,589

 
5

 
$
2,596

 
116

 
$
23,185

 
Six Months Ended June 30, 2020
 
Accruing Interest
 
Nonaccrual
 
Total

Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
January 1, 2020
122

 
$
21,194

 
9

 
$
3,543

 
131

 
$
24,737

New modifications
7

 
2,924

 
1

 
493

 
8

 
3,417

Principal advances (payments)

 
(1,074
)
 

 
(130
)
 

 
(1,204
)
Loans paid off
(19
)
 
(2,559
)
 
(2
)
 
(850
)
 
(21
)
 
(3,409
)
Transfers to OREO

 

 
(2
)
 
(356
)
 
(2
)
 
(356
)
Transfers to accrual status
1

 
104

 
(1
)
 
(104
)
 

 

June 30, 2020
111

 
$
20,589

 
5

 
$
2,596

 
116

 
$
23,185


45


 
Three Months Ended June 30, 2019
 
Accruing Interest
 
Nonaccrual
 
Total

Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
April 1, 2019
128

 
$
22,305

 
26

 
$
3,825

 
154

 
$
26,130

New modifications
2

 
1,348

 

 

 
2

 
1,348

Principal advances (payments)

 
(380
)
 

 
(133
)
 

 
(513
)
Loans paid off
(6
)
 
(394
)
 
(6
)
 
(541
)
 
(12
)
 
(935
)
Partial charge-offs

 

 

 
(65
)
 

 
(65
)
Transfers to accrual status
1

 
77

 
(1
)
 
(77
)
 

 

Transfers to nonaccrual status
(3
)
 
(2,646
)
 
3

 
2,646

 

 

June 30, 2019
122

 
$
20,310

 
22

 
$
5,655

 
144

 
$
25,965

 
Six Months Ended June 30, 2019
 
Accruing Interest
 
Nonaccrual
 
Total

Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
January 1, 2019
133

 
$
23,400

 
28

 
$
3,551

 
161

 
$
26,951

New modifications
5

 
2,018

 

 

 
5

 
2,018

Principal advances (payments)

 
(720
)
 

 
(260
)
 

 
(980
)
Loans paid off
(12
)
 
(1,193
)
 
(9
)
 
(718
)
 
(21
)
 
(1,911
)
Partial charge-offs

 

 

 
(65
)
 

 
(65
)
Transfers to OREO

 

 
(1
)
 
(48
)
 
(1
)
 
(48
)
Transfers to accrual status
1

 
77

 
(1
)
 
(77
)
 

 

Transfers to nonaccrual status
(5
)
 
(3,272
)
 
5

 
3,272

 

 

June 30, 2019
122

 
$
20,310

 
22

 
$
5,655

 
144

 
$
25,965

The following table summarizes our TDRs as of:
 
June 30, 2020
 
December 31, 2019
 
 

Accruing
Interest
 
Nonaccrual
 
Total
 
Accruing
Interest
 
Nonaccrual
 
Total
 
Total
Change
Current
$
20,402

 
$
488

 
$
20,890

 
$
20,847

 
$
507

 
$
21,354

 
$
(464
)
Past due 30-59 days
134

 

 
134

 
346

 

 
346

 
(212
)
Past due 60-89 days

 
2,108

 
2,108

 
1

 

 
1

 
2,107

Past due 90 days or more
53

 

 
53

 

 
3,036

 
3,036

 
(2,983
)
Total
$
20,589

 
$
2,596

 
$
23,185

 
$
21,194

 
$
3,543

 
$
24,737

 
$
(1,552
)
Additional disclosures about TDRs are included in “Note 4 – Loans and ALLL” of our interim condensed consolidated financial statements.

46


Impaired Loans
The following is a summary of information pertaining to impaired loans as of:
 
June 30, 2020
 
December 31, 2019

Recorded
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
 
Recorded
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
TDRs
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
4,828

 
$
5,082

 
$
63

 
$
5,325

 
$
5,643

 
$
15

Commercial other
1,921

 
1,921

 

 
1,156

 
1,156

 

Agricultural real estate
9,185

 
9,185

 
58

 
9,182

 
9,181

 
12

Agricultural other
2,918

 
2,918

 
2

 
4,421

 
4,421

 
14

Residential real estate senior liens
4,333

 
4,615

 
742

 
4,641

 
4,923

 
922

Home equity lines of credit

 

 

 
12

 
312

 

Total TDRs
23,185

 
23,721

 
865

 
24,737

 
25,636

 
963

Other impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
147

 
209

 

 
153

 
216

 

Commercial other
1,339

 
1,339

 

 
1,231

 
1,231

 

Agricultural real estate
705

 
755

 
3

 
699

 
750

 

Agricultural other
383

 
383

 

 
538

 
538

 

Residential real estate senior liens
481

 
627

 
82

 
760

 
907

 
151

Home equity lines of credit
112

 
112

 

 
73

 
73

 

Total other impaired loans
3,167

 
3,425

 
85

 
3,454

 
3,715

 
151

Total impaired loans
$
26,352

 
$
27,146

 
$
950

 
$
28,191

 
$
29,351

 
$
1,114

We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recognition of a charge-off.
We have implemented payment programs for borrowers to alleviate the financial setback due to the temporary closure of businesses and lost wages. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.

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

47


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

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
Nonaccrual status loans
$
5,319

 
$
6,913

 
$
6,535

 
$
6,962

 
$
8,107

Accruing loans past due 90 days or more
53

 
40

 

 
40

 
110

Total nonperforming loans
5,372

 
6,953

 
6,535

 
7,002

 
8,217

Foreclosed assets
776

 
564

 
456

 
468

 
513

Debt securities
230

 
230

 
230

 
230

 
230

Total nonperforming assets
$
6,378

 
$
7,747

 
$
7,221

 
$
7,700

 
$
8,960

Nonperforming loans as a % of total loans
0.42
%
 
0.59
%
 
0.55
%
 
0.59
%
 
0.70
%
Nonperforming assets as a % of total assets
0.33
%
 
0.43
%
 
0.40
%
 
0.42
%
 
0.49
%
The accrual of interest on commercial and agricultural loans, as well as residential real estate loans, is discontinued at the time a loan is 90 days or more past due unless the credit is well-secured and in the process of short-term collection. Upon transferring a loan to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if a charge-off is necessary. Consumer loans are typically charged-off no later than 180 days past due. Loans may be placed back on accrual status after six months of continued performance and achievement of current payment status. While the level of nonperforming loans has fluctuated in recent periods, it remains low in comparison to peer banks. Recent fluctuations in nonaccrual loans have been concentrated in our agricultural portfolio as a result of the challenges facing much of the agricultural industry.
The following table summarizes nonaccrual loans as of:

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
Commercial
$
1,367

 
$
1,643

 
$
1,621

 
$
1,632

 
$
1,692

Agricultural
3,656

 
4,606

 
4,285

 
4,520

 
5,532

Residential real estate
296

 
661

 
629

 
810

 
883

Consumer

 
3

 

 

 

Total
$
5,319

 
$
6,913

 
$
6,535

 
$
6,962

 
$
8,107

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

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
Commercial
$
28

 
$
304

 
$
390

 
$
390

 
$
450

Agricultural
2,568

 
3,441

 
3,048

 
3,309

 
5,096

Residential real estate

 
104

 
105

 
107

 
109

Total
$
2,596

 
$
3,849

 
$
3,543

 
$
3,806

 
$
5,655

We have implemented payment programs for borrowers to alleviate the financial setback due to the temporary closure of businesses and lost wages. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.
Additional disclosures about nonaccrual status loans are included in “Note 4 – Loans and ALLL” of our interim condensed consolidated financial statements.

48


Noninterest Income and Noninterest Expenses
Significant noninterest income balances are highlighted in the following tables for the:
 
Three Months Ended June 30
 
 
 
 
 
Change

2020
 
2019
 
$
 
%
Service charges and fees
 
 
 
 
 
 
 
ATM and debit card fees
$
883

 
$
780

 
$
103

 
13.21
 %
Service charges and fees on deposit accounts
350

 
566

 
(216
)
 
(38.16
)%
Freddie Mac servicing fee
155

 
161

 
(6
)
 
(3.73
)%
Net OMSR income (loss)
(89
)
 
(50
)
 
(39
)
 
(78.00
)%
Other fees for customer services
87

 
83

 
4

 
4.82
 %
Total service charges and fees
1,386

 
1,540

 
(154
)
 
(10.00
)%
Wealth management fees
656

 
780

 
(124
)
 
(15.90
)%
Gains from redemption of corporate owned life insurance policies
349

 

 
349

 
N/M

Net gain on sale of mortgage loans
466

 
116

 
350

 
301.72
 %
Earnings on corporate owned life insurance policies
189

 
201

 
(12
)
 
(5.97
)%
All other
200

 
374

 
(174
)
 
(46.52
)%
Total noninterest income
$
3,246

 
$
3,011

 
$
235

 
7.80
 %
 
Six Months Ended June 30
 
 
 
 
 
Change

2020
 
2019
 
$
 
%
Service charges and fees
 
 
 
 
 
 
 
ATM and debit card fees
$
1,677

 
$
1,465

 
$
212

 
14.47
 %
Service charges and fees on deposit accounts
937

 
1,096

 
(159
)
 
(14.51
)%
Freddie Mac servicing fee
314

 
311

 
3

 
0.96
 %
Net OMSR income (loss)
(350
)
 
(38
)
 
(312
)
 
(821.05
)%
Other fees for customer services
161

 
167

 
(6
)
 
(3.59
)%
Total service charges and fees
2,739

 
3,001

 
(262
)
 
(8.73
)%
Wealth management fees
1,228

 
1,457

 
(229
)
 
(15.72
)%
Gains from redemption of corporate owned life insurance policies
873

 

 
873

 
N/M

Net gain on sale of mortgage loans
617

 
209

 
408

 
195.22
 %
Earnings on corporate owned life insurance policies
371

 
374

 
(3
)
 
(0.80
)%
All other
416

 
449

 
(33
)
 
(7.35
)%
Total noninterest income
$
6,244

 
$
5,490

 
$
754

 
13.73
 %
ATM and debit card fees fluctuate from period to period based primarily on usage of ATM and debit cards. While we do not anticipate significant changes to our ATM and debit card fee structure, we do expect that fee income will continue to increase during the remainder of 2020 as the usage of ATM and debit cards continues to increase.
Service charges and fees on deposit accounts have declined as a result of waived fees. In response to COVID-19, which has led to an increase in the need for electronic services and products, we elected to temporarily waive certain charges and fees to ease the financial stress of our customers. Overall, 2020 income may decrease when compared to 2019.
OMSR income results are driven, in part, by changes in offering rates on residential mortgage loans, anticipated prepayments in the servicing-retained portfolio, and the volume of loans within the servicing-retained portfolio. Increased prepayment speeds, as a result of a decline in interest rates, were the primary driver of the losses recognized during the year. Income during 2020 could experience fluctuations and could vary from 2019 levels.

49


The decrease in wealth management fees was driven by a reduction in the market value of investment assets under management. With the uncertainty in the stock market as a result of COVID-19, wealth management fees during the remainder of 2020 may not exceed 2019 levels.
We recognized gains during the first and second quarters of 2020 due to the redemption of corporate owned life insurance policies in connection with the passing of a retired executive officer and a retired loan officer.
Net gain on sale of mortgage loans fluctuates primarily as the result of a change in the amount of loans sold. The amount of loans sold can fluctuate based on balance sheet management strategies. We experienced a significant increase in loan demand which led to an increase in the balance of loans sold during the year. As such, net gain on sale of mortgage loans is expected to exceed 2019 during 2020.
The fluctuations in all other income are spread throughout various categories, none of which are individually significant.

50


Significant noninterest expense balances are highlighted in the following tables for the:
 
Three Months Ended June 30
 
 
 
 
 
Change

2020
 
2019
 
$
 
%
Compensation and benefits
$
5,793

 
$
5,957

 
$
(164
)
 
(2.75
)%
Furniture and equipment
1,431

 
1,409

 
22

 
1.56
 %
Occupancy
912

 
834

 
78

 
9.35
 %
Other
 
 
 
 
 
 
 
Audit, consulting, and legal fees
498

 
453

 
45

 
9.93
 %
ATM and debit card fees
328

 
298

 
30

 
10.07
 %
Marketing costs
265

 
171

 
94

 
54.97
 %
Donations and community relations
105

 
190

 
(85
)
 
(44.74
)%
Loan underwriting fees
212

 
168

 
44

 
26.19
 %
Director fees
177

 
190

 
(13
)
 
(6.84
)%
Memberships and subscriptions
159

 
176

 
(17
)
 
(9.66
)%
FDIC insurance premiums
144

 
162

 
(18
)
 
(11.11
)%
Postage and freight
121

 
121

 

 
 %
All other
555

 
620

 
(65
)
 
(10.48
)%
Total other noninterest expenses
2,564

 
2,549

 
15

 
0.59
 %
Total noninterest expenses
$
10,700

 
$
10,749

 
$
(49
)
 
(0.46
)%
 
Six Months Ended June 30
 
 
 
 
 
Change

2020
 
2019
 
$
 
%
Compensation and benefits
$
11,662


$
11,679

 
$
(17
)
 
(0.15
)%
Furniture and equipment
2,892


2,903

 
(11
)
 
(0.38
)%
Occupancy
1,779


1,764

 
15

 
0.85
 %
Other
 
 
 
 
 
 
 
Audit, consulting, and legal fees
931

 
906

 
25

 
2.76
 %
ATM and debit card fees
651

 
546

 
105

 
19.23
 %
Marketing costs
468

 
313

 
155

 
49.52
 %
Donations and community relations
435

 
330

 
105

 
31.82
 %
Loan underwriting fees
378

 
484

 
(106
)
 
(21.90
)%
Director fees
359

 
397

 
(38
)
 
(9.57
)%
Memberships and subscriptions
358

 
343

 
15

 
4.37
 %
FDIC insurance premiums
300

 
332

 
(32
)
 
(9.64
)%
Postage and freight
252

 
250

 
2

 
0.80
 %
All other
1,180

 
1,291

 
(111
)
 
(8.60
)%
Total other noninterest expenses
5,312

 
5,192

 
120

 
2.31
 %
Total noninterest expenses
$
21,645

 
$
21,538

 
$
107

 
0.50
 %
Marketing costs increased during 2020 as a result of new campaigns, Isabella Wealth branding and increased disclosure mailings. Marketing costs can fluctuate from period to period based primarily on campaigns and other initiatives. As a result, 2020 expense may exceed expense from 2019.
Donations and community relations expense increased during 2020 as a result of initiatives designed to deepen and strengthen our relationship with the communities in which we operate and serve. In addition to providing monetary contributions, some of these initiatives include volunteering our time, which is not a component of donations and community relations costs. While these discretionary contributions incurred in 2020 resulted in increased expense, donations and community relations during the remainder of 2020 are not expected to exceed 2019 levels.

51


Loan underwriting fees were higher during the first half of 2019 as a result of new loan products, including first time home buyer and down payment assistance programs, that are no longer offered. Loan underwriting fees during 2020 are not expected to exceed 2019 levels.
The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.
Analysis of Changes in Financial Condition

June 30
2020
 
December 31
2019
 
$ Change
 
% Change
(unannualized)
ASSETS
 
 
 
 
 
 
 
Cash and cash equivalents
$
109,384

 
$
60,572

 
$
48,812

 
80.59
 %
AFS securities
 
 
 
 
 
 
 
Amortized cost of AFS securities
366,256

 
423,980

 
(57,724
)
 
(13.61
)%
Unrealized gains (losses) on AFS securities
14,158

 
5,859

 
8,299

 
141.65
 %
AFS securities
380,414

 
429,839

 
(49,425
)
 
(11.50
)%
Mortgage loans AFS
5,451

 
904

 
4,547

 
N/M

Loans
 
 
 
 


 
 
Gross loans
1,284,385

 
1,186,570

 
97,815

 
8.24
 %
Less allowance for loan and lease losses
8,877

 
7,939

 
938

 
11.82
 %
Net loans
1,275,508

 
1,178,631

 
96,877

 
8.22
 %
Premises and equipment
25,742

 
26,242

 
(500
)
 
(1.91
)%
Corporate owned life insurance policies
28,001

 
28,455

 
(454
)
 
(1.60
)%
Accrued interest receivable
7,715

 
6,501

 
1,214

 
18.67
 %
Equity securities without readily determinable fair values
21,660

 
21,629

 
31

 
0.14
 %
Goodwill and other intangible assets
48,353

 
48,379

 
(26
)
 
(0.05
)%
Other assets
10,999

 
13,046

 
(2,047
)
 
(15.69
)%
TOTAL ASSETS
$
1,913,227

 
$
1,814,198

 
$
99,029

 
5.46
 %
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Deposits
$
1,440,678

 
$
1,313,851

 
$
126,827

 
9.65
 %
Borrowed funds
236,268

 
275,999

 
(39,731
)
 
(14.40
)%
Accrued interest payable and other liabilities
16,290

 
14,166

 
2,124

 
14.99
 %
Total liabilities
1,693,236

 
1,604,016

 
89,220

 
5.56
 %
Shareholders’ equity
219,991

 
210,182

 
9,809

 
4.67
 %
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,913,227

 
$
1,814,198

 
$
99,029

 
5.46
 %
As shown above, total assets increased $99,029 from December 31, 2019. Cash and cash equivalents increased as a result of maturities and sales of AFS securities and an increase in customer deposits during 2020. We experienced a $97,815 increase in loans during the first six months of 2020 which was largely driven by SBA PPP loans in the commercial loan portfolio.
The following table outlines the changes in loan balances:

June 30
2020
 
December 31
2019
 
$ Change
 
% Change
(unannualized)
Commercial
$
799,632

 
$
700,941

 
$
98,691

 
14.08
 %
Agricultural
103,162

 
116,920

 
(13,758
)
 
(11.77
)%
Residential real estate
307,926

 
298,569

 
9,357

 
3.13
 %
Consumer
73,665

 
70,140

 
3,525

 
5.03
 %
Total
$
1,284,385

 
$
1,186,570

 
$
97,815

 
8.24
 %

52


The following table displays loan balances as of:

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
Commercial
$
799,632

 
$
695,278

 
$
700,941

 
$
708,735

 
$
701,954

Agricultural
103,162

 
108,856

 
116,920

 
118,460

 
120,363

Residential real estate
307,926

 
302,016

 
298,569

 
292,311

 
283,285

Consumer
73,665

 
69,786

 
70,140

 
72,298

 
71,020

Total
$
1,284,385

 
$
1,175,936

 
$
1,186,570

 
$
1,191,804

 
$
1,176,622

The competition for commercial loan opportunities continues to be strong in the current interest rate environment. Growth during the second quarter of 2020 was driven primarily by SBA PPP loans. As a result of the short-term nature of SBA PPP loans, we expect the commercial loan portfolio to decline during the remainder of 2020. During the second quarter of 2020, and over the past 12 months, agricultural loans have declined. Residential real estate and consumer loans experienced growth over the past year and continued growth is expected during the remainder of 2020.
The following table outlines the changes in deposit balances:

June 30
2020
 
December 31
2019
 
$ Change
 
% Change
(unannualized)
Noninterest bearing demand deposits
$
340,321

 
$
249,152

 
$
91,169

 
36.59
 %
Interest bearing demand deposits
263,567

 
229,865

 
33,702

 
14.66
 %
Savings deposits
458,167

 
427,215

 
30,952

 
7.25
 %
Certificates of deposit
352,118

 
365,049

 
(12,931
)
 
(3.54
)%
Brokered certificates of deposit
14,029

 
27,458

 
(13,429
)
 
(48.91
)%
Internet certificates of deposit
12,476

 
15,112

 
(2,636
)
 
(17.44
)%
Total
$
1,440,678

 
$
1,313,851

 
$
126,827

 
9.65
 %
The following table displays deposit balances as of:

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
Noninterest bearing demand deposits
$
340,321

 
$
249,424

 
$
249,152

 
$
242,179

 
$
244,240

Interest bearing demand deposits
263,567

 
237,392

 
229,865

 
230,579

 
228,704

Savings deposits
458,167

 
435,207

 
427,215

 
409,930

 
378,988

Certificates of deposit
352,118

 
358,534

 
365,049

 
357,984

 
359,945

Brokered certificates of deposit
14,029

 
27,458

 
27,458

 
52,744

 
57,773

Internet certificates of deposit
12,476

 
14,068

 
15,112

 
15,357

 
11,768

Total
$
1,440,678

 
$
1,322,083

 
$
1,313,851

 
$
1,308,773

 
$
1,281,418

Deposit growth during the second quarter of 2020 was largely driven by SBA PPP loan and government stimulus funds. Total deposits have increased over the past 12 months with significant growth in non-contractual deposits, such as demand and savings deposits. This trend is anticipated to continue during the remainder of 2020 as the financial markets continue to exhibit significant signs of instability. We experienced fluctuations in certificates of deposit over the past year while brokered certificates of deposit have significantly declined. Brokered certificates of deposit offer another source of funding and may fluctuate from period to period based on our funding needs, including changes in assets such as loans and investments. During 2019 and 2020, we used excess funds to reduce higher-cost deposits, such as brokered certificates of deposit.

53


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

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
Government sponsored enterprises
$

 
$

 
$

 
$

 
$
160

States and political subdivisions
146,785

 
163,116

 
169,752

 
175,575

 
176,742

Auction rate money market preferred
2,979

 
2,726

 
3,119

 
3,089

 
2,849

Mortgage-backed securities
119,029

 
126,554

 
140,204

 
150,120

 
173,340

Collateralized mortgage obligations
111,621

 
114,793

 
116,764

 
116,745

 
117,358

Total
$
380,414

 
$
407,189

 
$
429,839

 
$
445,529

 
$
470,449

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

June 30
2020
 
March 31
2020
 
December 31
2019
 
September 30
2019
 
June 30
2019
FHLB advances
$
205,000

 
$
235,000

 
$
245,000

 
$
245,000

 
$
295,000

Securities sold under agreements to repurchase without stated maturity dates
31,268

 
28,171

 
30,999

 
32,386

 
25,462

Total
$
236,268

 
$
263,171

 
$
275,999

 
$
277,386

 
$
320,462

Contractual Obligations and Loan Commitments
We have various financial obligations, including contractual obligations and commitments related to deposits and borrowings, which may require future cash payments. We also have loan related commitments that may impact liquidity. The commitments include unused lines of credit, commercial and standby letters of credit, and commitments to grant loans. These commitments to grant loans include residential mortgage loans with the majority committed to be sold to the secondary market. Many of these commitments historically have expired without being drawn upon and do not necessarily represent our future cash requirements.
We are party to credit related financial instruments with off-balance-sheet risk. These financial instruments are entered into in the normal course of business to meet the financing needs of our customers. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contractual or notional amounts of these instruments reflect the extent of involvement we have in a particular class of financial instrument.
Our exposure to credit-related loss in the event of nonperformance by the counter parties to the financial instruments for commitments to extend credit and standby letters of credit could be up to the contractual notional amount of those instruments. We use the same credit policies as we do for extending loans to customers. No significant losses are anticipated as a result of these commitments.

54


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 127,216 shares or $2,343 of common stock during the first six months of 2020, as compared to 104,598 shares or $2,436 of common stock during the same period in 2019. We also offer the Directors Plan in which participants purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $233 and $271 during the six-month periods ended June 30, 2020 and June 30, 2019, respectively.
We have publicly announced a common stock repurchase plan. Pursuant to this plan, we repurchased 61,001 shares or $1,195 of common stock during the first six months of 2020 and 57,073 shares or $1,339 during the first six months of 2019. As of June 30, 2020, we were authorized to repurchase up to an additional 186,905 shares of common stock.
The FRB has established minimum risk based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital.
The common equity tier 1 capital ratio has a minimum requirement of 4.50%. The minimum standard for primary, or Tier 1 capital is 6.00% and the minimum standard for total capital is 8.00%. The minimum requirements presented below include the minimum required capital levels based on the Basel III Capital Rules. Capital requirements to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. The following table sets forth these requirements and our ratios as of:
 
June 30, 2020
 
December 31, 2019
 
Actual
 
Minimum Required - BASEL III
 
Required to be Considered Well Capitalized
 
Actual
 
Minimum Required - BASEL III
 
Required to be Considered Well Capitalized
Common equity tier 1 capital
12.90
%
 
7.00
%
 
6.50
%
 
12.56
%
 
7.000
%
 
6.50
%
Tier 1 capital
12.90
%
 
8.50
%
 
8.00
%
 
12.56
%
 
8.500
%
 
8.00
%
Total capital
13.60
%
 
10.50
%
 
10.00
%
 
13.18
%
 
10.500
%
 
10.00
%
Tier 1 leverage
8.86
%
 
4.00
%
 
5.00
%
 
9.01
%
 
4.00
%
 
5.00
%
There are no significant regulatory constraints placed on our capital. At June 30, 2020, the Bank exceeded minimum capital requirements.
Liquidity
Liquidity is monitored regularly by our Market Risk Committee, which consists of members of senior management. The committee reviews projected cash flows, key ratios, and liquidity available from both primary and secondary sources.
Our primary sources of liquidity are cash and cash equivalents and unencumbered AFS securities. These categories totaled $346,508 or 18.11% of assets as of June 30, 2020, compared to $291,190 or 16.05% as of December 31, 2019. The increase in the amount and percentage of primary liquidity is a direct result of an increase in market deposits and a deliberate reduction in non-market funding which required collateralization. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Based on these same factors, daily liquidity could vary significantly.
Deposit accounts are our primary source of funds. Our secondary sources include the ability to borrow from the FHLB, from the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. In recent periods, we have elected to use excess funds and proceeds from the sale of AFS securities to reduce borrowings and other higher-cost funding sources. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As of June 30, 2020, we had available lines of credit of $144,495.

55


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

June 30
2020
Total cash and cash equivalents
$
109,384

Available lines of credit
 
Fed funds lines with correspondent banks
93,000

FHLB borrowings
35,233

FRB Discount Window
11,262

Other lines of credit
5,000

Total available lines of credit
144,495

Unencumbered lendable value of FRB collateral, estimated1
196,000

Total cash and liquidity
$
449,879

(1) 
Includes estimated unencumbered lendable value of FHLB collateral of $144,000
The following table summarizes our sources and uses of cash for the six-month period ended June 30:

2020
 
2019
 
$ Variance
Net cash provided by (used in) operating activities
$
6,606

 
$
12,101

 
$
(5,495
)
Net cash provided by (used in) investing activities
(40,819
)
 
(14,686
)
 
(26,133
)
Net cash provided by (used in) financing activities
83,025

 
(34,924
)
 
117,949

Increase (decrease) in cash and cash equivalents
48,812

 
(37,509
)
 
86,321

Cash and cash equivalents January 1
60,572

 
73,471

 
(12,899
)
Cash and cash equivalents June 30
$
109,384

 
$
35,962

 
$
73,422

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 interim condensed consolidated financial statements.

56


Market Risk
Our primary market risks are interest rate risk and liquidity risk. IRR is the exposure of our net interest income to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. IRR is the fundamental method by which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to our earnings and capital.
The FRB has adopted a policy requiring banks to effectively manage the various risks that can have a material impact on safety and soundness. The risks include credit, interest rate, liquidity, operational, and reputational. We have policies, procedures, and internal controls for measuring and managing these risks. Specifically, our Funds Management policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long-term assets, limiting the mismatch in repricing opportunities of assets and liabilities, and the frequency of measuring and reporting to our Board.
The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield curves, interest rate relationships, loan prepayments, and funding sources. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic rate environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits.
Gap analysis, the secondary method to measure IRR, measures the cash flows and/or the earliest repricing of our interest bearing assets and liabilities. This analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the embedded repricing options contained in assets and liabilities. Residential real estate and consumer loans allow the borrower to repay the balance prior to maturity without penalty, while commercial and agricultural loans may have prepayment penalties. The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current offering rates, the level of home sales, and the overall availability of credit in the market place. Generally, a decrease in interest rates will result in an increase in cash flows from these assets. A significant portion of our securities are callable or have prepayment options. The call and prepayment options are more likely to be exercised in a period of decreasing interest rates. Savings and demand accounts may generally be withdrawn on request without prior notice. The timing of cash flows from these deposits is estimated based on historical experience. Certificates of deposit have penalties that discourage early withdrawals.
Our primary market risk exposures with the onset of the COVID-19 crisis is uncertain. A review of our market risk methods are ongoing and modeling is incorporating additional assumptions to account for this uncertainty related to this crisis. Repricing, cash flows, and prepayment projections for loans and mortgage-backed securities are not expected to behave as they would be expected to in a more stable interest rate environment. The SBA PPP loan is a new instrument and has payment characteristics that are still uncertain. In late March 2020, we implemented loan payment programs for customers to alleviate the financial setback caused by the temporary closure of businesses and lost wages.  Under these programs, borrowers whose loans were in good standing as of March 1, 2020 could elect to defer full or partial payments for a short period of time. Customer deposit flows may experience unusual fluctuations due to government support programs, customer and business stress, and general money supply. We continue to closely monitor customer and economic indicators to develop more precise market risk assumptions as the economic impact of this crisis begins to reveal itself.

57


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 June 30, 2020, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as of June 30, 2020, were effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the most recent fiscal quarter, no change occurred in our internal control over financial reporting that materially affected, or is likely to materially affect, our internal control over financial reporting.

58


PART II – OTHER INFORMATION
Item 1. Legal Proceedings.
We are not involved in any material legal proceedings. We are involved in ordinary, routine litigation incidental to our business; however, no such routine proceedings are expected to result in any material adverse effect on operations, earnings, financial condition, or cash flows.
Item 1A. Risk Factors.
Other than the addition of risk related to COVID-19, as described below, there have been no material changes to the risk factors disclosed in Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2019.
The COVID-19 pandemic may adversely affect our business
Unexpected and unprecedented changes have occurred during the year as the result of COVID-19.  This aggressive and persistent virus causes a respiratory disease that currently has no approved vaccine or antiviral treatment and can result in serious illness or death.  The World Health Organization has declared the situation a global pandemic.
The pandemic has created significant market volatility, economic uncertainty, and disruption to normal business operations around the world, with slowdowns and shutdowns affecting entire industries.  The Michigan governor issued on March 23, 2020 a stay-at-home order, which limited gatherings and travel, and required those in select businesses who were not deemed essential to sustain or protect life to stay home.  The Michigan stay-at-home order was in effect until early June.  The orders led to financial stress for many businesses and their employees throughout the communities we serve.
The extent to which COVID-19 impacts our business will depend on future developments, which are highly uncertain and cannot be predicted with any accuracy. Future developments include new information which may emerge concerning the severity of COVID-19 and the actions to contain the coronavirus or treat its impact, among others. We expect the significance of the COVID-19 pandemic, including the extent of its effect on our financial and operational results, to be dictated by, among other factors, its duration, the success of efforts to contain it and the impact of actions taken in response. Uncertainty created by the COVID-19 pandemic is pervasive, and the pandemic has impacted our operations, customers, vendors and various areas of risk. Other areas of risk may include, but are not limited to, cybersecurity, credit, interest rate, litigation and risk related to vendor services. With the uncertainty created by COVID-19, it's challenging to determine the full impact of the COVID-19 pandemic on our ongoing financial and operational results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(A)
None
(B)
None
(C)
Repurchases of Common Stock
We have adopted and publicly announced a common stock repurchase plan. The plan was last amended on December 23, 2019, to allow for the repurchase of an additional 250,000 shares of common stock after that date. These authorizations do not have expiration dates. As common shares are repurchased under this plan, they are retired and revert back to the status of authorized, but unissued common shares.
The following table provides information for the three-month period ended June 30, 2020, with respect to this plan:
 
Common Shares Repurchased
 
Total Number of Common Shares Purchased as Part of Publicly Announced Plan or Program
 
Maximum Number of Common Shares That May Yet Be Purchased Under the Plans or Programs

Number
 
Average Price
Per Common Share
 
 
Balance, March 31
 
 
 
 
 
 
188,486

April 1 - 30
664

 
$
16.57

 
664

 
187,822

May 1 - 31
229

 
17.47

 
229

 
187,593

June 1 -30
688

 
17.44

 
688

 
186,905

Balance, June 30
1,581

 
$
17.08

 
1,581

 
186,905


59


Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Not applicable.
Item 6. Exhibits.
(a) Exhibits
Exhibit Number
 
Exhibits
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
101.1*
 
101.INS (XBRL Instance Document)
 
 
 
 
 
101.SCH (XBRL Taxonomy Extension Schema Document)
 
 
 
 
 
101.CAL (XBRL Calculation Linkbase Document)
 
 
 
 
 
101.LAB (XBRL Taxonomy Label Linkbase Document)
 
 
 
 
 
101.DEF (XBRL Taxonomy Linkbase Document)
 
 
 
 
 
101.PRE (XBRL Taxonomy Presentation Linkbase Document)
*
In accordance with Rule 406T of Regulations S-T, the XBRL related information shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

60


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

61