ISABELLA BANK Corp - Quarter Report: 2020 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



ý	Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934

For the quarterly period ended March 31, 2020



¨	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 7,927,845 as of April 28, 2020.

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ISABELLA BANK CORPORATION

QUARTERLY REPORT ON FORM 10-Q

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PART I – FINANCIAL INFORMATION		4

Item 1.	Financial Statements	4

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

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	54

Item 4.	Controls and Procedures	54

PART II – OTHER INFORMATION		55

Item 1.	Legal Proceedings	55

Item 1A.	Risk Factors	55

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

Item 3.	Defaults Upon Senior Securities	56

Item 4.	Mine Safety Disclosures	56

Item 5.	Other Information	56

Item 6.	Exhibits	56

SIGNATURES		57

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Forward Looking Statements

This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended and Rule 3b-6 promulgated thereunder. We intend such forward looking statements to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, and are included in this statement for purposes of these safe harbor provisions. Forward looking statements, which are based on certain assumptions and describe future plans, strategies and expectations, are generally identifiable by use of the words “believe”, “expect”, “intend”, “anticipate”, “estimate”, “project”, or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, federal or state tax laws, monetary and fiscal policy, a health crisis, the quality or composition of the loan or investment portfolio, demand for loan products, fluctuation in the value of collateral securing our loan portfolio, deposit flows, competition, cybersecurity risk, demand for financial services in our market area, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward looking statements and undue reliance should not be placed on such statements. Further information concerning our business, including additional factors that could materially affect our financial results, is included in our filings with the SEC.

Glossary of Acronyms and Abbreviations

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



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

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(Dollars in thousands)



	March 31 2020		December 31 2019
ASSETS
Cash and cash equivalents
Cash and demand deposits due from banks	$	19,160	$	20,311
Interest bearing balances due from banks	77,591		40,261
Total cash and cash equivalents	96,751		60,572
AFS securities, at fair value	407,189		429,839
Mortgage loans AFS	1,228		904
Loans
Commercial	695,278		700,941
Agricultural	108,856		116,920
Residential real estate	302,016		298,569
Consumer	69,786		70,140
Gross loans	1,175,936		1,186,570
Less allowance for loan and lease losses	8,697		7,939
Net loans	1,167,239		1,178,631
Premises and equipment	25,946		26,242
Corporate owned life insurance policies	27,691		28,455
Accrued interest receivable	7,022		6,501
Equity securities without readily determinable fair values	21,535		21,629
Goodwill and other intangible assets	48,366		48,379
Other assets	12,937		13,046
TOTAL ASSETS	$	1,815,904	$	1,814,198
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest bearing	$	249,424	$	249,152
Interest bearing demand deposits	237,392		229,865
Certificates of deposit under $250 and other savings	739,925		739,023
Certificates of deposit over $250	95,342		95,811
Total deposits	1,322,083		1,313,851
Borrowed funds	263,171		275,999
Accrued interest payable and other liabilities	15,152		14,166
Total liabilities	1,600,406		1,604,016
Shareholders’ equity
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,921,291 shares (including 44,687 shares held in the Rabbi Trust) in 2020 and 7,910,804 shares (including 27,069 shares held in the Rabbi Trust) in 2019	140,945		141,069
Shares to be issued for deferred compensation obligations	4,802		5,043
Retained earnings	63,041		62,099
Accumulated other comprehensive income (loss)	6,710		1,971
Total shareholders’ equity	215,498		210,182
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,815,904	$	1,814,198

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

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(Dollars in thousands except per share amounts)



	Three Months Ended March 31
	2020		2019
Interest income
Loans, including fees	$	13,254	$	12,891
AFS securities
Taxable	1,489		1,958
Nontaxable	1,053		1,253
Federal funds sold and other	405		379
Total interest income	16,201		16,481
Interest expense
Deposits	2,791		2,718
Borrowings	1,408		1,574
Total interest expense	4,199		4,292
Net interest income	12,002		12,189
Provision for loan losses	788		34
Net interest income after provision for loan losses	11,214		12,155
Noninterest income
Service charges and fees	1,353		1,461
Investment and trust advisory fees	572		677
Gains from redemption of corporate owned life insurance policies	524		—
Earnings on corporate owned life insurance policies	182		184
Net gain on sale of mortgage loans	151		93
Other	216		75
Total noninterest income	2,998		2,490
Noninterest expenses
Compensation and benefits	5,869		5,722
Furniture and equipment	1,461		1,494
Occupancy	867		930
Other	2,748		2,654
Total noninterest expenses	10,945		10,800
Income before federal income tax expense	3,267		3,845
Federal income tax expense	203		349
NET INCOME	$	3,064	$	3,496
Earnings per common share
Basic	$	0.39	$	0.44
Diluted	$	0.38	$	0.43
Cash dividends per common share	$	0.27	$	0.26

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

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(Dollars in thousands)



	Three Months Ended March 31
	2020			2019
Net income	$	3,064		$	3,496
Unrealized gains (losses) on AFS securities arising during the period	6,311			5,954
Reclassification adjustment for net (gains) losses included in net income	(71		)	—
Tax effect ⁽¹⁾	(1,393		)	(1,195		)
Unrealized gains (losses) on AFS securities, net of tax	4,847			4,759
Unrealized gains (losses) on derivative instruments arising during the period	(136		)	(81		)
Tax effect ⁽¹⁾	28			17
Unrealized gains (losses) on derivative instruments, net of tax	(108		)	(64		)
Other comprehensive income (loss), net of tax	4,739			4,695
Comprehensive income (loss)	$	7,803		$	8,191


⁽¹⁾	See “Note 9 – Accumulated Other Comprehensive Income” for tax effect reconciliation.

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

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

(Dollars in thousands except per share amounts)



	Common Stock
	Common Shares Outstanding		Amount			Common Shares to be Issued for Deferred Compensation Obligations			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Totals
Balance, January 1, 2019	7,870,969		$	140,416		$	5,431		$	57,357		$	(7,685	)	$	195,519
Comprehensive income (loss)	—		—			—			3,496			4,695			8,191
Issuance of common stock	61,405		1,433			—			—			—			1,433
Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations	—		268			(268		)	—			—			—
Share-based payment awards under equity compensation plan	—		—			131			—			—			131
Common stock purchased for deferred compensation obligations	—		(186		)	—			—			—			(186		)
Common stock repurchased pursuant to publicly announced repurchase plan	(26,296	)	(632		)	—			—			—			(632		)
Cash dividends paid ($0.26 per common share)	—		—			—			(2,043		)	—			(2,043		)
Balance, March 31, 2019	7,906,078		$	141,299		$	5,294		$	58,810		$	(2,990	)	$	202,413
Balance, January 1, 2020	7,910,804		$	141,069		$	5,043		$	62,099		$	1,971		$	210,182
Comprehensive income (loss)	—		—			—			3,064			4,739			7,803
Issuance of common stock	69,907		1,330			—			—			—			1,330
Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations	—		364			(364		)	—			—			—
Share-based payment awards under equity compensation plan	—		—			123			—			—			123
Common stock purchased for deferred compensation obligations	—		(650		)	—			—			—			(650		)
Common stock repurchased pursuant to publicly announced repurchase plan	(59,420	)	(1,168		)	—			—			—			(1,168		)
Cash dividends paid ($0.27 per common share)	—		—			—			(2,122		)	—			(2,122		)
Balance, March 31, 2020	7,921,291		$	140,945		$	4,802		$	63,041		$	6,710		$	215,498

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

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Dollars in thousands)



	Three Months Ended March 31
	2020			2019
OPERATING ACTIVITIES
Net income	$	3,064		$	3,496
Reconciliation of net income to net cash provided by operating activities:
Undistributed earnings of equity securities without readily determinable fair values	94			57
Provision for loan losses	788			34
Depreciation	668			731
Amortization of OMSR	97			44
Amortization of acquisition intangibles	13			19
Net amortization of AFS securities	444			435
Net gains on sale of AFS securities	(71		)	—
Net gain on sale of mortgage loans	(151		)	(93		)
OMSR impairment loss	245			—
Net gains on foreclosed assets	(42		)	(33		)
Increase in cash value of corporate owned life insurance policies, net of expenses	(170		)	(173		)
Gains from redemption of corporate owned life insurance policies	(524		)	—
Share-based payment awards under equity compensation plan	123			131
Origination of loans held-for-sale	(8,890		)	(6,520		)
Proceeds from loan sales	8,717			6,826
Net changes in operating assets and liabilities which provided (used) cash:
Accrued interest receivable	(521		)	(823		)
Other assets	(379		)	(1,492		)
Accrued interest payable and other liabilities	(111		)	437
Net cash provided by (used in) operating activities	3,394			3,076
INVESTING ACTIVITIES
Activity in AFS securities
Sales	26,855			—
Maturities, calls, and principal payments	12,674			11,824
Purchases	(11,012		)	(6,313		)
Net loan principal (originations) collections	10,487			(16,373		)
Proceeds from sales of foreclosed assets	51			224
Purchases of premises and equipment	(372		)	(340		)
Proceeds from redemption of corporate owned life insurance policies	1,458			—
Funding of low income housing tax credit investments	(150		)	(117		)
Net cash provided by (used in) investing activities	39,991			(11,095		)

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Dollars in thousands)



	Three Months Ended March 31
	2020			2019
FINANCING ACTIVITIES
Net increase (decrease) in deposits	$	8,232		$	(14,730	)
Net increase (decrease) in borrowed funds	(12,828		)	(28,615		)
Cash dividends paid on common stock	(2,122		)	(2,043		)
Proceeds from issuance of common stock	1,330			1,433
Common stock repurchased	(1,168		)	(632		)
Common stock purchased for deferred compensation obligations	(650		)	(186		)
Net cash provided by (used in) financing activities	(7,206		)	(44,773		)
Increase (decrease) in cash and cash equivalents	36,179			(52,792		)
Cash and cash equivalents at beginning of period	60,572			73,471
Cash and cash equivalents at end of period	$	96,751		$	20,679
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid	$	4,214		$	4,227
SUPPLEMENTAL NONCASH INFORMATION:
Transfers of loans to foreclosed assets	$	117		$	237

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

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NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands except per share amounts)

Note 1 – Basis of Presentation

As used in these notes, as well as in Management's Discussion and Analysis of Financial Condition and Results of Operations, references to the “Corporation”, “Isabella”, “we”, “our”, “us”, and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiary. References to Isabella Bank or the “Bank” refer to Isabella Bank Corporation’s subsidiary, Isabella Bank.

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2019.

Our accounting policies are materially the same as those discussed in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2019.

Reclassifications: Certain amounts reported in the interim 2019 consolidated financial statements have been reclassified to conform with the 2020 presentation.

Note 2 – Accounting Standards Updates

Recently Adopted

ASU No. 2018-13: “Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement”

In August 2018, ASU No. 2018-13 was issued and provided updated framework related to fair value disclosures. For entities required to make disclosures about recurring or nonrecurring fair value measurements, the update provides disclosure modifications which include the removal, modification and addition of specific disclosure requirements.

The new authoritative guidance was effective January 1, 2020 and did not have a significant impact on our financial statement disclosures.

ASU No. 2018-15: “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract”

In August 2018, ASU No. 2018-15 was issued and provided guidance on the accounting for implementation, setup, and

other upfront costs (collectively referred to as implementation costs) for entities that are a customer in a hosting arrangement that is a service contract. The guidance also provides clarification on requirements to capitalize implementation costs and the required accounting for expenses related to capitalization of implementation costs.

The new authoritative guidance was effective January 1, 2020. Based on the prospective approach, we will review future arrangements to determine the appropriate treatment under this guidance. These changes are not expected to have a significant impact on our operating results or financial statement disclosures.

Pending

ASU No. 2016-13: “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”

In June 2016, ASU No. 2016-13 was issued and updated the measurement for credit losses for AFS debt securities and assets measured at amortized cost which include loans, trade receivables, and any other financial assets with the contractual right to receive cash. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. Under the incurred loss approach, entities are limited to a probable initial recognition threshold when credit losses are measured under GAAP; an entity generally only considers past events and current conditions in measuring the incurred loss.

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Under the new guidance, the incurred loss impairment methodology in current GAAP is replaced with a methodology that reflects current expected credit losses (CECL). This methodology requires consideration of a broader range of reasonable and supportable information to calculate credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances which applies to assets measured either collectively or individually.

The update allows an entity to revert to historical loss information that is reflective of the contractual term (considering the effect of prepayments) for periods that are beyond the time frame for which the entity is able to develop reasonable and supportable forecasts. In addition, the disclosures of credit quality indicators in relation to the amortized cost of financing receivables, a current disclosure requirement, are further disaggregated by year of origination (or vintage). The vintage information will be useful for financial statement users to better assess changes in underwriting standards and credit quality trends in asset portfolios over time and the effect of those changes on credit losses.

Overall, the update will allow entities the ability to measure expected credit losses without the restriction of incurred or probable losses that exist under current GAAP. For users of the financial statements, the update requires disclosure of decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The new authoritative guidance was originally effective for interim and annual periods beginning after December 15, 2019. Effective October 16, 2019, the FASB approved changes to the implementation date of this guidance for some filers. As a small reporting company, as defined by the SEC, our implementation date was delayed from January 1, 2020 to January 1, 2023. Early adoption continues to be permissible under the revised implementation date; currently we have no plans for early adoption. This guidance may have a significant impact on the results of our operations and financial statement disclosures as well as that of the banking industry as a whole.

We have invested a considerable amount of effort toward this guidance and will continue to invest considerable effort until our implementation date. A committee was formed and is accountable for timely and accurate adoption of the guidance. A service provider that has focused on the ALLL for more than 10 years and serves hundreds of financial institutions has been engaged to provide us with education, advisory, and software solutions exclusively related to the ACL. We will run parallel processes which will help to ensure we are ready to calculate, review, and report the ACL by the required implementation date.

ASU No. 2018-14: “Compensation - Retirement Benefits - Defined Pension Plans - General (Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans”

In August 2018, ASU No. 2018-14 was issued and provided an updated framework related to defined benefit plans. For employers that sponsor defined benefit pension or other postretirement plans, the update provides disclosure modifications which include the removal of six specific requirements, the addition of two specific requirements and clarification to existing requirements.

Disclosure additions include 1) the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates; 2) an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. Clarification items relate to 1) the projected benefit obligation (PBO) and fair value of plan assets for plans with PBOs in excess of plan assets; and 2) the accumulated benefit obligation (ABO) and fair value of plan assets for plans with ABOs in excess of plan assets.

The new authoritative guidance is effective for fiscal years ending after December 15, 2020, with early adoption permitted, and will likely impact our financial statement disclosures.

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Note 3 – AFS Securities

The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:



	March 31, 2020
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
States and political subdivisions	$	159,267	$	3,849	$	—	$	163,116
Auction rate money market preferred	3,200		—		474		2,726
Mortgage-backed securities	122,544		4,010		—		126,554
Collateralized mortgage obligations	110,079		4,714		—		114,793
Total	$	395,090	$	12,573	$	474	$	407,189



	December 31, 2019
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
States and political subdivisions	$	165,005	$	4,747	$	—	$	169,752
Auction rate money market 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 March 31, 2020 are as follows:



	Maturing								Securities with Variable Monthly Payments or Noncontractual Maturities
	Due in One Year or Less		After One Year But Within Five Years		After Five Years But Within Ten Years		After Ten Years				Total
States and political subdivisions	$	27,544	$	69,886	$	38,580	$	23,257	$	—	$	159,267
Auction rate money market preferred	—		—		—		—		3,200		3,200
Mortgage-backed securities	—		—		—		—		122,544		122,544
Collateralized mortgage obligations	—		—		—		—		110,079		110,079
Total amortized cost	$	27,544	$	69,886	$	38,580	$	23,257	$	235,823	$	395,090
Fair value	$	27,616	$	71,184	$	39,799	$	24,517	$	244,073	$	407,189

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

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

A summary of the sales activity of AFS securities was as follows for the three months ended March 31, 2020. There were no sales of AFS securities for the three months ended March 31, 2019.



	March 31 2020
Proceeds from sales of AFS securities	$	26,855
Realized gains (losses)	$	71
Applicable income tax expense (benefit)	$	15

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



	March 31, 2020
	Twelve Months or More
	Gross Unrealized Losses		Fair Value
Auction rate money market preferred	$	474	$	2,726
Number of securities in an unrealized loss position:			2



	December 31, 2019
	Less Than Twelve Months				Twelve Months or More
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Total Unrealized Losses
Auction rate money market preferred	$	—	$	—	$	81	$	3,119	$	81
Mortgage-backed 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 March 31, 2020 and December 31, 2019, we conducted an analysis to determine whether any AFS securities currently in an unrealized loss position should be identified as other-than-temporarily impaired. Such analyses considered, among other factors, the following criteria:


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


•	Is the investment credit rating below investment grade?


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


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


•	Has the duration of the investment been extended?

Based on our analysis, which included the criteria outlined above and the fact that we have asserted that we do not have to sell any AFS securities in an unrealized loss position, we do not believe that the values of any AFS securities are other-than-temporarily impaired as of March 31, 2020 or December 31, 2019, with the exception of one municipal bond previously identified which had no activity during the period.

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Note 4 – Loans and ALLL

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

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

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

When a loan is placed in nonaccrual status or charged-off, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the ALLL. Loans may be returned to accrual status after six months of continuous performance and achievement of current payment status.

Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, advances to mortgage brokers, farmland and agricultural production, and loans to states and political subdivisions. Repayment of these loans is dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of direct credit exposure to any one borrower to $15,000. Borrowers with direct credit needs of more than $15,000 may be serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans commonly require loan-to-value limits of 80% or less. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, property, or equipment. Government agency guarantee may be required. Personal guarantees and/or life insurance beneficiary assignments are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we may require annual financial statements, prepare cash flow analyses, and review credit reports.

We entered into a mortgage purchase program in 2016 with a financial institution where we participate in advances to mortgage brokers (“advances”). The mortgage brokers originate residential mortgage loans with the intent to sell them on the secondary market. We participate in the advance to the mortgage broker, which is secured by the underlying mortgage loan, until it is ultimately sold on the secondary market. As such, the average life of each participated advance is approximately 20-30 days. Funds from the sale of the loan are used to pay off our participation in the advance to the mortgage broker. We classify these advances as commercial loans and include the outstanding balance in commercial loans on our consolidated balance sheets. Under the participation agreement, we committed to a maximum outstanding aggregate amount of $50,000. The difference between our outstanding balance and the maximum outstanding aggregate amount is classified as “Unfunded commitments under lines of credit” in the “Contractual Obligations and Loan Commitments” section of the Management's Discussion and Analysis of Financial Condition and Results of Operations of this report.

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

Our lending policies generally limit the maximum loan-to-value ratio on residential real estate loans to 100% of the lower of the appraised value of the property or the purchase price. Private mortgage insurance is typically required on loans with loan-to-value ratios in excess of 80% unless the loan qualifies for government guarantees.

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Underwriting criteria for originated residential real estate loans generally include:


•	Evaluation of the borrower’s ability to make monthly payments.


•	Evaluation of the value of the property securing the loan.


•	Ensuring the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower’s gross income.


•	Ensuring all debt servicing does not exceed 40% of income.


•	Verification of acceptable credit reports.


•	Verification of employment, income, and financial information.

Appraisals are performed by independent appraisers and are reviewed for appropriateness. Generally, mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market underwriting system; loans in excess of $1,000 require the approval of our Internal Loan Committee, the Executive Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors.

Consumer loans include secured and unsecured personal loans. Loans are amortized for a period of up to 15 years based on the age and value of the underlying collateral. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market.

The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Full or partial loan balances are charged against the ALLL when we believe uncollectability is probable. Subsequent recoveries, if any, are credited to the ALLL.

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

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

While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong at March 31, 2020. However, the COVID-19 pandemic has led to the temporary closure of businesses throughout the communities in which we serve, which has also led to increased unemployment. Therefore, we increased the ALLL during the quarter to account for inherent risk within the loan portfolio as of March 31, 2020. We continue to monitor the economic impact from COVID-19 as it relates to credit risk to ensure the ALLL is appropriate.

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



	Allowance for Loan Losses
	Three Months Ended March 31, 2020
	Commercial			Agricultural			Residential Real Estate			Consumer			Unallocated		Total
January 1, 2020	$	1,914		$	634		$	2,047		$	922		$	2,422	$	7,939
Charge-offs	(4		)	(16		)	(15		)	(123		)	—		(158		)
Recoveries	22			33			27			46			—		128
Provision for loan losses	443			(161		)	(342		)	116			732		788
March 31, 2020	$	2,375		$	490		$	1,717		$	961		$	3,154	$	8,697

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	Allowance for Loan Losses and Recorded Investment in Loans
	March 31, 2020
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
ALLL
Individually evaluated for impairment	$	179	$	78	$	1,052	$	—	$	—	$	1,309
Collectively evaluated for impairment	2,196		412		665		961		3,154		7,388
Total	$	2,375	$	490	$	1,717	$	961	$	3,154	$	8,697
Loans
Individually evaluated for impairment	$	8,598	$	13,660	$	5,374	$	3			$	27,635
Collectively evaluated for impairment	686,680		95,196		296,642		69,783				1,148,301
Total	$	695,278	$	108,856	$	302,016	$	69,786			$	1,175,936



	Allowance for Loan Losses
	Three Months Ended March 31, 2019
	Commercial			Agricultural			Residential Real Estate			Consumer			Unallocated			Total
January 1, 2019	$	2,563		$	775		$	1,992		$	857		$	2,188		$	8,375
Charge-offs	(8		)	—			(2		)	(128		)	—			(138		)
Recoveries	51			1			27			48			—			127
Provision for loan losses	(358		)	(1		)	288			114			(9		)	34
March 31, 2019	$	2,248		$	775		$	2,305		$	891		$	2,179		$	8,398



	Allowance for Loan Losses and Recorded Investment in Loans
	December 31, 2019
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
ALLL
Individually evaluated for impairment	$	15	$	26	$	1,073	$	—	$	—	$	1,114
Collectively evaluated for 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

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The following tables display the internally assigned credit risk ratings for commercial and agricultural credit exposures as of:



	March 31, 2020
	Commercial								Agricultural
	Real Estate		Other		Advances to Mortgage Brokers		Total		Real Estate		Other		Total		Total
Rating
1 - Excellent	$	—	$	10	$	—	$	10	$	—	$	—	$	—	$	10
2 - High quality	4,326		10,760		—		15,086		894		13		907		15,993
3 - High satisfactory	93,092		43,940		34,416		171,448		16,835		4,976		21,811		193,259
4 - Low satisfactory	381,334		92,789		—		474,123		42,602		19,671		62,273		536,396
5 - Special mention	15,404		3,530		—		18,934		5,601		2,164		7,765		26,699
6 - Substandard	7,177		6,857		—		14,034		8,236		3,258		11,494		25,528
7 - Vulnerable	29		1,339		—		1,368		2,839		1,579		4,418		5,786
8 - Doubtful	275		—		—		275		188		—		188		463
9 - Loss	—		—		—		—		—		—		—		—
Total	$	501,637	$	159,225	$	34,416	$	695,278	$	77,195	$	31,661	$	108,856	$	804,134



	December 31, 2019
	Commercial								Agricultural
	Real Estate		Other		Advances to Mortgage Brokers		Total		Real Estate		Other		Total		Total
Rating
1 - Excellent	$	—	$	390	$	—	$	390	$	—	$	—	$	—	$	390
2 - High 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

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.

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2. HIGH QUALITY – Limited Risk

Credit with sound financial condition and a positive trend in earnings supplemented by:


•	Favorable liquidity and leverage ratios.


•	Ability to meet all obligations when due.


•	Management with successful track record.


•	Steady and satisfactory earnings history.


•	If loan is secured, collateral is of high quality and readily marketable.


•	Access to alternative financing.


•	Well defined primary and secondary source of repayment.


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

3. HIGH SATISFACTORY – Reasonable Risk

Credit with satisfactory financial condition and further characterized by:


•	Working capital adequate to support operations.


•	Cash flow sufficient to pay debts as scheduled.


•	Management experience and depth appear favorable.


•	Loan performing according to terms.


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

4. LOW SATISFACTORY – Acceptable Risk

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


•	Would include most start-up businesses.


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


•	Management’s abilities are apparent yet unproven.


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


•	Loan structure generally in accordance with policy.


•	If secured, loan collateral coverage is marginal.

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

5. SPECIAL MENTION – Criticized

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


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


•	Impaired working capital position.


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


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


•	Shrinking equity cushion.


•	Diminishing primary source of repayment and questionable secondary source.


•	Management abilities are questionable.


•	Weak industry conditions.


•	Litigation pending against the borrower.


•	Loan may need to be restructured to improve collateral position or reduce payments.


•	Collateral or guaranty offers limited protection.


•	Negative debt service coverage, however the credit is well collateralized and payments are current.

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6. SUBSTANDARD – Classified

Credit is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged. There is a distinct possibility we will implement collection procedures if the loan deficiencies are not corrected. Any commercial loan placed in nonaccrual status will be rated “7” or worse. In addition, the following characteristics may apply:


•	Sustained losses have severely eroded the equity and cash flow.


•	Deteriorating liquidity.


•	Serious management problems or internal fraud.


•	Original repayment terms liberalized.


•	Likelihood of bankruptcy.


•	Inability to access other funding sources.


•	Reliance on secondary source of repayment.


•	Litigation filed against borrower.


•	Interest non-accrual may be warranted.


•	Collateral provides little or no value.


•	Requires excessive attention of the loan officer.


•	Borrower is uncooperative with loan officer.

7. VULNERABLE – Classified

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


•	Insufficient cash flow to service debt.


•	Minimal or no payments being received.


•	Limited options available to avoid the collection process.


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

8. DOUBTFUL – Workout

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


•	Normal operations are severely diminished or have ceased.


•	Seriously impaired cash flow.


•	Original repayment terms materially altered.


•	Secondary source of repayment is inadequate.


•	Survivability as a “going concern” is impossible.


•	Collection process has begun.


•	Bankruptcy petition has been filed.


•	Judgments have been filed.


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

9. LOSS – Charge-off

Credit is considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification is for charged-off loans but does not mean that the asset has absolutely no recovery or salvage value. These loans are further characterized by:


•	Liquidation or reorganization under Bankruptcy, with poor prospects of collection.


•	Fraudulently overstated assets and/or earnings.


•	Collateral has marginal or no value.


•	Debtor cannot be located.


•	Over 120 days delinquent.

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Our primary credit quality indicator for residential real estate and consumer loans is the individual loan’s past due aging. The following tables summarize the past due and current loans for the entire loan portfolio as of:



	March 31, 2020
	Accruing Interest and Past Due:								Total Past Due and Nonaccrual
	30-59 Days		60-89 Days		90 Days or More		Nonaccrual				Current		Total
Commercial
Commercial real estate	$	2,199	$	94	$	—	$	304	$	2,597	$	499,040	$	501,637
Commercial other	2,135		109		—		1,339		3,583		155,642		159,225
Advances to mortgage brokers	—		—		—		—		—		34,416		34,416
Total commercial	4,334		203		—		1,643		6,180		689,098		695,278
Agricultural
Agricultural real estate	233		—		—		3,027		3,260		73,935		77,195
Agricultural other	—		31		—		1,579		1,610		30,051		31,661
Total agricultural	233		31		—		4,606		4,870		103,986		108,856
Residential real estate
Senior liens	2,472		77		40		576		3,165		258,959		262,124
Junior liens	35		—		—		—		35		5,509		5,544
Home equity lines of credit	141		—		—		85		226		34,122		34,348
Total residential real estate	2,648		77		40		661		3,426		298,590		302,016
Consumer
Secured	356		—		—		—		356		66,105		66,461
Unsecured	7		—		—		3		10		3,315		3,325
Total consumer	363		—		—		3		366		69,420		69,786
Total	$	7,578	$	311	$	40	$	6,913	$	14,842	$	1,161,094	$	1,175,936

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	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

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Impaired Loans

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


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


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


3.	The loan is in nonaccrual status.

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

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



	March 31, 2020						December 31, 2019
	Recorded Balance		Unpaid Principal Balance		Valuation Allowance		Recorded Balance		Unpaid Principal Balance		Valuation Allowance
Impaired loans with a valuation allowance
Commercial real estate	$	1,125	$	1,367	$	66	$	517	$	635	$	15
Commercial other	919		919		113		—		—		—
Agricultural real estate	2,247		2,297		70		1,509		1,509		12
Agricultural other	1,355		1,355		8		1,355		1,355		14
Residential real estate senior liens	5,285		5,713		1,052		5,401		5,830		1,073
Total impaired loans with a valuation allowance	10,931		11,651		1,309		8,782		9,329		1,114
Impaired loans without a valuation allowance
Commercial real estate	4,162		4,301				4,961		5,224
Commercial other	2,392		2,392				2,387		2,387
Agricultural real estate	7,192		7,192				8,372		8,422
Agricultural other	2,866		2,866				3,604		3,604
Home equity lines of credit	89		389				85		385
Consumer secured	3		3				—		—
Total impaired loans without a valuation allowance	16,704		17,143				19,409		20,022
Impaired loans
Commercial	8,598		8,979		179		7,865		8,246		15
Agricultural	13,660		13,710		78		14,840		14,890		26
Residential real estate	5,374		6,102		1,052		5,486		6,215		1,073
Consumer	3		3		—		—		—		—
Total impaired loans	$	27,635	$	28,794	$	1,309	$	28,191	$	29,351	$	1,114

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The following is a summary of impaired loans for the:



	Three Months Ended March 31
	2020				2019
	Average Recorded Balance		Interest Income Recognized		Average Recorded Balance		Interest Income Recognized
Impaired loans with a valuation allowance
Commercial real estate	$	821	$	25	$	3,409	$	49
Commercial other	460		6		12		—
Agricultural real estate	1,878		24		390		6
Agricultural other	1,355		22		44		—
Residential real estate senior liens	5,343		55		6,682		68
Residential real estate junior liens	—		—		12		—
Total impaired loans with a valuation allowance	9,857		132		10,549		123
Impaired loans without a valuation allowance
Commercial real estate	4,562		59		3,287		53
Commercial other	2,390		15		2,970		21
Agricultural real estate	7,782		59		7,623		7
Agricultural other	3,235		7		6,087		70
Home equity lines of credit	87		6		43		6
Consumer secured	2		—		9		—
Total impaired loans without a valuation allowance	18,058		146		20,019		157
Impaired loans
Commercial	8,233		105		9,678		123
Agricultural	14,250		112		14,144		83
Residential real estate	5,430		61		6,737		74
Consumer	2		—		9		—
Total impaired loans	$	27,915	$	278	$	30,568	$	280

As a result of line of credit agreements with borrowers, we had committed to advance $459 and $175 in additional funds to be disbursed in connection with impaired loans as of March 31, 2020 and December 31, 2019, respectively.

Troubled Debt Restructurings

A loan modification is considered to be a TDR when the modification includes terms outside of normal lending practices to a borrower who is experiencing financial difficulties.

Typical concessions granted include, but are not limited to:

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

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

•Agreeing to an interest only payment structure and delaying principal payments.

•Forgiving principal.

•Forgiving accrued interest.

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


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


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


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


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


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

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The following is a summary of TDRs granted for the:



	Three Months Ended March 31
	2020					2019
	Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial other	2	$	963	$	963	1	$	147	$	147
Agricultural other	2	593		593		2	523		523
Residential real estate	2	93		93		—	—		—
Total	6	$	1,649	$	1,649	3	$	670	$	670

The following is a summary of concessions we granted to borrowers in financial difficulty for the:



	Three Months Ended March 31
	2020						2019
	Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period			Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period
	Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment
Commercial other	1	$	919	1	$	44	—	$	—	1	$	147
Agricultural other	—	—		2	593		—	—		2	523
Residential real estate	—	—		2	93		—	—		—	—
Total	1	$	919	5	$	730	—	$	—	3	$	670

We did not restructure any loans by forgiving principal or accrued interest in the three-month periods ended March 31, 2020 or 2019.

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

We had no loans that defaulted in the three-month periods ended March 31, 2020 and March 31, 2019 which were modified within 12 months prior to the default date.

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



	March 31 2020		December 31 2019
TDRs	$	24,117	$	24,737

Measures we have taken to assist our customers in connection with the COVID-19 pandemic include loan programs that provide short-term payment relief. Under these programs, borrowers who were in good standing as of March 1, 2020 can elect to defer full or partial payments for a 90-day period. Bank regulators issued a statement on March 22, 2020, and a revised statement on April 7, 2020, which provides confirmation that short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers with a current payment status are not categorized as TDRs.

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Note 5 – Borrowed Funds

Borrowed funds consist of the following obligations as of:



	March 31, 2020				December 31, 2019
	Amount		Rate		Amount		Rate
FHLB advances	$	235,000	2.34	%	$	245,000	2.32	%
Securities sold under agreements to repurchase without stated maturity dates	28,171		0.09	%	30,999		0.09	%
Total	$	263,171	2.10	%	$	275,999	2.07	%

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

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



	March 31, 2020				December 31, 2019
	Amount		Rate		Amount		Rate
Fixed rate due 2020	$	45,000	2.28	%	$	55,000	2.18	%
Fixed rate due 2021	50,000		1.91	%	50,000		1.91	%
Variable rate due 2021 ⁽¹⁾	10,000		1.99	%	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	$	235,000	2.34	%	$	245,000	2.32	%


⁽¹⁾	Hedged advance (see “Derivative Instruments” section below)

Securities sold under agreements to repurchase are classified as secured borrowings and are reflected at the amount of cash received in connection with the transaction. The securities underlying the agreements have a carrying value and a fair value of $28,171 and $31,020 at March 31, 2020 and December 31, 2019, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.

Securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances generally mature within one to four days from the transaction date. We had no FRB Discount Window advances during the three-month periods ended March 31, 2020 and March 31, 2019. A summary of securities sold under repurchase agreements without stated maturity dates and federal funds purchased was as follows for the:



	Three Months Ended March 31
	2020						2019
	Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period		Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates	$	32,236	$	30,923	0.10	%	$	37,441	$	34,987	0.10	%
Federal funds purchased	—		—		—	%	1,860		458		2.65	%

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



	March 31 2020		December 31 2019
Pledged to secure borrowed funds	$	364,985	$	368,310
Pledged to secure repurchase agreements	28,171		31,020
Pledged for public deposits and for other purposes necessary or required by law	57,129		59,537
Total	$	450,285	$	458,867

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



	March 31 2020		December 31 2019
States and political subdivisions	$	12,002	$	31,020
Mortgage-backed securities	9,492		—
Collateralized mortgage obligations	6,677		—
Total	$	28,171	$	31,020

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

As of March 31, 2020, we had the ability to borrow up to an additional $140,121, based on assets pledged as collateral. We had no investment securities that were restricted to be pledged for specific purposes.

Derivative Instruments

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

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

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



	March 31, 2020
	Pay Rate		Receive Rate	Remaining Life (Years)	Notional Amount		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments
Cash Flow Hedges:
Interest rate swaps	1.56	%	3-Month LIBOR	1.1	$	10,000	Other liabilities	$	(69	)

December 31, 2019

Pay Rate

Receive Rate

Remaining Life (Years)

Notional Amount

Balance Sheet Location

Fair Value

Derivatives designated as hedging instruments

Cash Flow Hedges:

Interest rate swaps

1.56

3-Month LIBOR

1.3

10,000

Other assets

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.

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Note 6 – Computation of Earnings Per Common Share

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

Earnings per common share have been computed based on the following for the:



	Three Months Ended March 31
	2020		2019
Average number of common shares outstanding for basic calculation	7,892,421		7,888,885
Average potential effect of common shares in the Directors Plan ⁽¹⁾	163,186		199,456
Average number of common shares outstanding used to calculate diluted earnings per common share	8,055,607		8,088,341
Net income	$	3,064	$	3,496
Earnings per common share
Basic	$	0.39	$	0.44
Diluted	$	0.38	$	0.43


⁽¹⁾	Exclusive of shares held in the Rabbi Trust

Note 7 – Other Noninterest Expenses

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



	Three Months Ended March 31
	2020		2019
Audit, consulting, and legal fees	$	433	$	453
Donations and community relations	330		140
ATM and debit card fees	323		248
Marketing costs	203		142
Memberships and subscriptions	199		167
Director fees	182		207
Loan underwriting fees	166		316
FDIC insurance premiums	156		170
Postage and freight	131		129
Education and travel	91		157
All other	534		525
Total other noninterest expenses	$	2,748	$	2,654

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Note 8 – Federal Income Taxes

The reconciliation of the provision for federal income taxes and the amount computed at the federal statutory tax rate of income before federal income tax expense is as follows for the:



	Three Months Ended March 31
	2020			2019
Income taxes at statutory rate	$	686		$	807
Effect of nontaxable income
Interest income on tax exempt municipal securities	(203		)	(244		)
Earnings on corporate owned life insurance policies	(148		)	(36		)
Other	(4		)	(4		)
Total effect of nontaxable income	(355		)	(284		)
Effect of nondeductible expenses	4			6
Effect of tax credits	(132		)	(180		)
Federal income tax expense	$	203		$	349

Note 9 – Accumulated Other Comprehensive Income

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



	Three Months Ended March 31
	2020												2019
	Unrealized Gains (Losses) on AFS Securities			Unrealized Gains (Losses) on Derivative Instruments			Defined Benefit Pension Plan			Total			Unrealized Gains (Losses) on AFS Securities			Unrealized Gains (Losses) on Derivative Instruments			Defined Benefit Pension Plan			Total
Balance, January 1	$	4,612		$	54		$	(2,695	)	$	1,971		$	(5,200	)	$	256		$	(2,741	)	$	(7,685	)
OCI before reclassifications	6,311			(136		)	—			6,175			5,954			(81		)	—			5,873
Amounts reclassified from AOCI	(71		)	—			—			(71		)	—			—			—			—
Subtotal	6,240			(136		)	—			6,104			5,954			(81		)	—			5,873
Tax effect	(1,393		)	28			—			(1,365		)	(1,195		)	17			—			(1,178		)
OCI, net of tax	4,847			(108		)	—			4,739			4,759			(64		)	—			4,695
Balance, March 31	$	9,459		$	(54	)	$	(2,695	)	$	6,710		$	(441	)	$	192		$	(2,741	)	$	(2,990	)

Included in OCI for the three-month periods ended March 31, 2020 and March 31, 2019 are changes in unrealized gains and losses related to auction rate money market preferred stocks. These investments, for federal income tax purposes, have no deferred federal income taxes related to unrealized gains or losses given the nature of the investments.

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



	Three Months Ended March 31
	2020									2019
	Auction Rate Money Market Preferred Stocks			All Other AFS Securities			Total			Auction Rate Money Market Preferred Stocks		All Other AFS Securities			Total
Unrealized gains (losses) arising during the period	$	(393	)	$	6,704		$	6,311		$	265	$	5,689		$	5,954
Reclassification adjustment for net (gains) losses included in net income	—			(71		)	(71		)	—		—			—
Net unrealized gains (losses)	(393		)	6,633			6,240			265		5,689			5,954
Tax effect	—			(1,393		)	(1,393		)	—		(1,195		)	(1,195		)
Unrealized gains (losses), net of tax	$	(393	)	$	5,240		$	4,847		$	265	$	4,494		$	4,759

Note 10 – Fair Value

Under fair value measurement and disclosure authoritative guidance, we group assets and liabilities measured at fair value into three levels, based on the markets in which the assets and liabilities are traded, and the reliability of the assumptions used to determine fair value, based on the prioritization of inputs in the valuation techniques. These levels are:



Level 1:	Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2:	Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3:	Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.

The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. Transfers between measurement levels are recognized at the end of reporting periods.

Fair value measurement requires the use of an exit price notion which may differ from entrance pricing. Generally we believe our assets and liabilities classified as Level 1 or Level 2 approximate an exit price notion.

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

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

Loans: We do not record loans at fair value on a recurring basis. However, some loans are classified as impaired and a specific allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will be significantly different than the contractual terms of the original loan agreement are considered impaired. Once a loan is identified as impaired, we measure the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral, less costs to sell, if the loan is collateral dependent. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.

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

The following tables list the quantitative fair value information about impaired loans as of:



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



	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.

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Estimated Fair Values of Financial Instruments Not Recorded at Fair Value in their Entirety on a Recurring Basis

Disclosure of the estimated fair values of financial instruments, which differ from carrying values, often requires the use of estimates. In cases where quoted market values in an active market are not available, we use present value techniques and other valuation methods to estimate the fair values of our financial instruments. These valuation methods require considerable judgment and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used.

The carrying amount and estimated fair value of financial instruments not recorded at fair value in their entirety on a recurring basis were as follows as of:



	March 31, 2020
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
ASSETS
Cash and cash equivalents	$	96,751	$	96,751	$	96,751	$	—	$	—
Mortgage loans AFS	1,228		1,242		—		1,242		—
Gross loans	1,175,936		1,172,598		—		—		1,172,598
Less allowance for loan and lease losses	8,697		8,697		—		—		8,697
Net loans	1,167,239		1,163,901		—		—		1,163,901
Accrued interest receivable	7,022		7,022		7,022		—		—
Equity securities without readily determinable fair values ⁽¹⁾	21,535		N/A		—		—		—
OMSR	2,003		2,003		—		2,003		—
LIABILITIES
Deposits without stated maturities	922,023		922,023		922,023		—		—
Deposits with stated maturities	400,060		406,330		—		406,330		—
Borrowed funds	263,171		269,968		—		269,968		—
Accrued interest payable	845		845		845		—		—



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

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Financial Instruments Recorded at Fair Value

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



	March 31, 2020											December 31, 2019
	Total		Level 1			Level 2			Level 3			Total		Level 1			Level 2			Level 3
Recurring items
AFS securities
States and political subdivisions	$	163,116	$	—		$	163,116		$	—		$	169,752	$	—		$	169,752		$	—
Auction rate money market preferred	2,726		—			2,726			—			3,119		—			3,119			—
Mortgage-backed securities	126,554		—			126,554			—			140,204		—			140,204			—
Collateralized mortgage obligations	114,793		—			114,793			—			116,764		—			116,764			—
Total AFS securities	407,189		—			407,189			—			429,839		—			429,839			—
Derivative instruments	69		—			69			—			67		—			67			—
Nonrecurring items
Impaired loans (net of the ALLL)	18,778		—			—			18,778			19,135		—			—			19,135
OMSR	2,003		—			2,003			—			2,264		—			2,264			—
Total	$	428,039	$	—		$	409,261		$	18,778		$	451,305	$	—		$	432,170		$	19,135
Percent of assets and liabilities measured at fair value			—		%	95.61		%	4.39		%			—		%	95.76		%	4.24		%

We recorded an impairment related to OMSR of $245 and $0 through earnings for the three months ended March 31, 2020 and March 31, 2019. We had no other assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a recurring basis or nonrecurring basis, as of March 31, 2020. Further, we had no unrealized gains and losses for the period included in OCI for recurring Level 3 fair value measurements held at the end of the reporting period.

Note 11 – Operating Segments

Our reportable segments are based on legal entities that account for at least 10% of net operating results. The Bank as of March 31, 2020 and December 31, 2019 and for the three-month periods ended March 31, 2020 and March 31, 2019, represent approximately 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented.

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Note 12 – Parent Company Only Financial Information

Interim Condensed Balance Sheets



	March 31 2020		December 31 2019
ASSETS
Cash on deposit at the Bank	$	216	$	1,360
Investments in subsidiaries	163,889		157,415
Premises and equipment	1,528		1,539
Other assets	49,892		49,887
TOTAL ASSETS	$	215,525	$	210,201
LIABILITIES AND SHAREHOLDERS’ EQUITY
Other liabilities	$	27	$	19
Shareholders' equity	215,498		210,182
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	215,525	$	210,201

Interim Condensed Statements of Income



	Three Months Ended March 31
	2020		2019
Income
Dividends from subsidiaries	$	1,750	$	1,000
Interest income	1		2
Other income (loss)	1		(19		)
Total income	1,752		983
Expenses
Occupancy and equipment	15		15
Audit, consulting, and legal fees	132		130
Director fees	94		98
Other	293		290
Total expenses	534		533
Income before income tax benefit and equity in undistributed earnings of subsidiaries	1,218		450
Federal income tax benefit	112		115
Income before equity in undistributed earnings of subsidiaries	1,330		565
Undistributed earnings of subsidiaries	1,734		2,931
Net income	$	3,064	$	3,496

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Interim Condensed Statements of Cash Flows



	Three Months Ended March 31
	2020			2019
Operating activities
Net income	$	3,064		$	3,496
Adjustments to reconcile net income to cash provided by operations
Undistributed earnings of subsidiaries	(1,734		)	(2,931		)
Undistributed earnings of equity securities without readily determinable fair values	94			57
Share-based payment awards under equity compensation plan	123			131
Depreciation	11			11
Changes in operating assets and liabilities which provided (used) cash
Other assets	(100		)	26
Other liabilities	8			800
Net cash provided by (used in) operating activities	1,466			1,590
Investing activities - none
Financing activities
Cash dividends paid on common stock	(2,122		)	(2,043		)
Proceeds from the issuance of common stock	1,330			1,433
Common stock repurchased	(1,168		)	(632		)
Common stock purchased for deferred compensation obligations	(650		)	(186		)
Net cash provided by (used in) financing activities	(2,610		)	(1,428		)
Increase (decrease) in cash and cash equivalents	(1,144		)	162
Cash and cash equivalents at beginning of period	1,360			2,499
Cash and cash equivalents at end of period	$	216		$	2,661

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

ISABELLA BANK CORPORATION FINANCIAL REVIEW

(Dollars in thousands except per share amounts)

The following is management's discussion and analysis of our financial condition and results of operations for the unaudited three-month periods ended March 31, 2020 and March 31, 2019. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2019 and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 4 of this report.

Executive Summary

During the three months ended March 31, 2020, we reported net income of $3,064 and earnings per common share of $0.39. Net income and earnings per common share for the same period of 2019 were $3,496 and $0.44, respectively. A combination of reduced interest rates and loan volume were large drivers of a $280 decrease in interest income for the first three months of 2020 compared to the same period in 2019. Interest expense on deposits and borrowings decreased $93 for the three-month period ended March 31, 2020 compared to the same period in 2019 primarily due to reduced interest rates. Net interest income decreased by $187 for the three-month period ended March 31, 2020 in comparison to the same period in 2019. The provision for loan losses increased by $754 for the three-month period ended March 31, 2020 compared to the same period in 2019, as the result of increased economic and environmental risk factors, primarily driven by COVID-19, and an increase in impaired loan reserves. Noninterest income increased $508 during the first three months of 2020 compared to the same period in 2019, primarily as a result of a gain from the redemption of a corporate owned life insurance policy. Noninterest expenses for the first three months of 2020 modestly exceeded the same period in 2019 by $145, primarily due to compensation, community relations and donation-related expenses.

As of March 31, 2020, total assets and assets under management were $1,815,904 and $2,433,157, respectively. Assets under management include loans sold and serviced of $257,285 and investment and trust assets managed by Isabella Wealth of $359,968, in addition to assets on our consolidated balance sheet. In 2020, the Bank’s investment and trust services business was re-engineered and rebranded as Isabella Wealth to enhance the client experience, build scalability and expand market awareness.

Our securities portfolio has declined $22,650 since December 31, 2019, primarily as result of the sale of AFS securities. As a result of the flat yield curve that has existed for over a year, the opportunity to identify new investment securities for purchase at an acceptable yield has been minimal. Loans outstanding as of March 31, 2020 totaled $1,175,936. During the first three months of 2020, gross loans decreased $10,634 which was largely driven by a decline in our agricultural loan portfolio. Total deposits increased $8,232 during the first quarter of 2020, primarily due to increases in interest bearing demand and savings deposits, and totaled $1,322,083 as of March 31, 2020. All regulatory capital ratios for the Bank exceeded the minimum thresholds to be considered a “well capitalized” institution.

Our net yield on interest earning assets (FTE) was 2.98% for the three months ended March 31, 2020. This compares to 3.02% for the three months ended March 31, 2019. Management has implemented various initiatives to improve our net yield on interest earning assets, which include enhanced pricing strategies related to loan and deposit products and a reduced reliance on borrowings and brokered deposits as funding sources. However, the current interest rate environment has had a negative impact on our net yields on interest earning assets and future improvement may be gradual. We are actively committed to increasing earnings and shareholder value through growth in our loan portfolio while maintaining strong underwriting standards, growth in our investment and trust services, increasing our presence within our geographical footprint, and managing operating costs.

Recent Events and Legislation

Unexpected and unprecedented changes have occurred during the quarter as the result of COVID-19. COVID-19 is a new strain of coronavirus that spreads easily from person to person. The aggressive and persistent virus causes a respiratory disease that currently has no approved vaccine or antiviral treatment and can result in serious illness or death. The World Health Organization has declared the situation a global pandemic.

The pandemic has created significant market volatility, economic uncertainty, and disruption to normal business operations around the world, with slowdowns and shutdowns affecting entire industries. The Michigan governor issued on March 23, 2020 a stay-at-home order, which limits gatherings and travel, and requires workers who are not necessary to sustain or protect life to stay home. The Michigan stay-at-home order has since been extended to May 15. The orders, as the result of COVID-19, have led to financial stress for many businesses and workers throughout the communities we serve.

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The CARES Act, a massive and unprecedented federal government support program, was enacted on March 27, 2020. It is a $2 trillion stimulus package intended to provide financial relief across the country. The CARES Act includes the PPP, which enables small businesses to obtain a forgivable SBA loan to meet payroll, rent, utility, and mortgage interest obligations for the 8-week period following the loan origination, and re-open quickly once the public health crisis ends. The first applications for PPP funds were accepted April 3, 2020. We are proud to facilitate SBA PPP loans to businesses throughout the communities in which we serve.

Bank regulators issued an interim rule that neutralizes the regulatory capital effects by allowing a zero percent risk weight, for capital purposes, to loans originated under the PPP. The capital rule was issued April 9, 2020, and is effective immediately.

We have held discussions with many of our customers and they have expressed their general concern about the uncertain economic conditions, yet we believe it is premature to predict the magnitude of the impact at this point. Measures we have taken to assist our customers include loan programs that provide short-term payment relief. Under these programs, borrowers who were in good standing as of March 1, 2020 can elect to defer full or partial payments for a 90-day period. Bank regulators issued a statement on March 22, 2020, and a revised statement on April 7, 2020, which provides confirmation that short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers with a current payment status are not TDRs. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.

The extent to which COVID-19 impacts our business will depend on future developments, which are highly uncertain and cannot be predicted. Future developments include new information which may emerge concerning the severity of COVID-19 and the actions to contain the coronavirus or treat its impact, among others. We expect the significance of the COVID-19 pandemic, including the extent of its effect on our financial and operational results, to be dictated by, among other factors, its duration, the success of efforts to contain it and the impact of actions taken in response. Uncertainty created by the COVID-19 pandemic is pervasive, and the pandemic will likely impact our operations, customers, and various areas of risk; however, we are not able at this time to estimate the impact of the COVID-19 pandemic on our ongoing financial and operational results.

Reclassifications

Certain amounts reported in the interim 2019 consolidated financial statements have been reclassified to conform to the 2020 presentation.

Subsequent Events

We evaluated subsequent events after March 31, 2020 through the date the consolidated financial statements were issued for potential recognition and disclosure. Other than those noted in the Recent Events and Legislation section of this report, no subsequent events require financial statement recognition or disclosure between March 31, 2020 and the date the consolidated financial statements were issued.

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Results of Operations

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



	March 31 2020			December 31 2019			September 30 2019			June 30 2019			March 31 2019
INCOME STATEMENT DATA
Interest income	$	16,201		$	16,849		$	17,161		$	16,815		$	16,481
Interest expense	4,199			4,492			4,550			4,527			4,292
Net interest income	12,002			12,357			12,611			12,288			12,189
Provision for loan losses	788			(18		)	193			(179		)	34
Noninterest income	2,998			(725		)	3,274			3,011			2,490
Noninterest expenses	10,945			10,892			10,620			10,749			10,800
Federal income tax expense (benefit)	203			(140		)	630			541			349
Net income	$	3,064		$	898		$	4,442		$	4,188		$	3,496
PER SHARE
Basic earnings	$	0.39		$	0.12		$	0.56		$	0.53		$	0.44
Diluted earnings	$	0.38		$	0.11		$	0.55		$	0.52		$	0.43
Dividends	$	0.27		$	0.27		$	0.26		$	0.26		$	0.26
Tangible book value	$	21.10		$	20.45		$	20.66		$	20.17		$	19.47
Quoted market value
High	$	24.50		$	24.80		$	23.45		$	23.75		$	24.50
Low	$	16.00		$	22.25		$	22.01		$	22.25		$	22.25
Close ⁽¹⁾	$	18.00		$	24.31		$	22.30		$	23.25		$	23.75
Common shares outstanding ⁽¹⁾	7,921,291			7,910,804			7,938,234			7,918,494			7,906,078
PERFORMANCE RATIOS
Return on average total assets	0.68		%	0.20		%	0.98		%	0.93		%	0.77		%
Return on average shareholders' equity	5.68		%	1.66		%	8.37		%	8.13		%	7.00		%
Return on average tangible shareholders' equity	7.35		%	2.18		%	10.87		%	10.67		%	9.29		%
Net interest margin yield (FTE)	2.98		%	3.06		%	3.13		%	3.06		%	3.02		%
BALANCE SHEET DATA ⁽¹⁾
Gross loans	$	1,175,936		$	1,186,570		$	1,191,804		$	1,176,622		$	1,144,832
AFS securities	$	407,189		$	429,839		$	445,529		$	470,449		$	494,842
Total assets	$	1,815,904		$	1,814,198		$	1,813,684		$	1,824,592		$	1,806,974
Deposits	$	1,322,083		$	1,313,851		$	1,308,773		$	1,281,418		$	1,277,963
Borrowed funds	$	263,171		$	275,999		$	277,386		$	320,462		$	311,684
Shareholders' equity	$	215,498		$	210,182		$	212,376		$	208,114		$	202,413
Gross loans to deposits	88.95		%	90.31		%	91.06		%	91.82		%	89.58		%
ASSETS UNDER MANAGEMENT ⁽¹⁾
Loans sold with servicing retained	$	257,285		$	259,375		$	258,873		$	257,062		$	259,127
Assets managed by Isabella Wealth	$	359,968		$	436,181		$	475,574		$	487,180		$	475,560
Total assets under management	$	2,433,157		$	2,509,754		$	2,548,131		$	2,568,834		$	2,541,661
ASSET QUALITY ⁽¹⁾
Nonperforming loans to gross loans	0.59		%	0.55		%	0.59		%	0.70		%	0.64		%
Nonperforming assets to total assets	0.43		%	0.40		%	0.42		%	0.49		%	0.44		%
ALLL to gross loans	0.74		%	0.67		%	0.69		%	0.68		%	0.73		%
CAPITAL RATIOS ⁽¹⁾
Shareholders' equity to assets	11.87		%	11.59		%	11.71		%	11.41		%	11.20		%
Tier 1 leverage	9.09		%	9.01		%	9.16		%	9.03		%	8.91		%
Common equity tier 1 capital	12.72		%	12.56		%	12.58		%	12.43		%	12.45		%
Tier 1 risk-based capital	12.72		%	12.56		%	12.58		%	12.43		%	12.45		%
Total risk-based capital	13.41		%	13.18		%	13.21		%	13.06		%	13.12		%

⁽¹⁾ At end of period

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



	March 31 2020			March 31 2019			March 31 2018
INCOME STATEMENT DATA
Interest income	$	16,201		$	16,481		$	15,121
Interest expense	4,199			4,292			3,401
Net interest income	12,002			12,189			11,720
Provision for loan losses	788			34			384
Noninterest income	2,998			2,490			2,487
Noninterest expenses	10,945			10,800			10,096
Federal income tax expense (benefit)	203			349			265
Net income	$	3,064		$	3,496		$	3,462
PER SHARE
Basic earnings	$	0.39		$	0.44		$	0.44
Diluted earnings	$	0.38		$	0.43		$	0.43
Dividends	$	0.27		$	0.26		$	0.26
Tangible book value	$	21.10		$	19.47		$	19.16
Quoted market value
High	$	24.50		$	24.50		$	28.25
Low	$	16.00		$	22.25		$	26.11
Close ⁽¹⁾	$	18.00		$	23.75		$	27.40
Common shares outstanding ⁽¹⁾	7,921,291			7,906,078			7,894,341
PERFORMANCE RATIOS
Return on average total assets	0.68		%	0.77		%	0.77		%
Return on average shareholders' equity	5.68		%	7.00		%	7.11		%
Return on average tangible shareholders' equity	1.84		%	9.29		%	9.23		%
Net interest margin yield (FTE)	2.98		%	3.02		%	2.95		%
BALANCE SHEET DATA ⁽¹⁾
Gross loans	$	1,175,936		$	1,144,832		$	1,093,002
AFS securities	$	407,189		$	494,842		$	547,762
Total assets	$	1,815,904		$	1,806,974		$	1,799,592
Deposits	$	1,322,083		$	1,277,963		$	1,297,868
Borrowed funds	$	263,171		$	311,684		$	303,113
Shareholders' equity	$	215,498		$	202,413		$	191,090
Gross loans to deposits	88.95		%	89.58		%	84.22		%
ASSETS UNDER MANAGEMENT ⁽¹⁾
Loans sold with servicing retained	$	257,285		$	259,127		$	262,541
Assets managed by Isabella Wealth	$	359,968		$	475,560		$	470,578
Total assets under management	$	2,433,157		$	2,541,661		$	2,532,711
ASSET QUALITY ⁽¹⁾
Nonperforming loans to gross loans	0.59		%	0.64		%	0.63		%
Nonperforming assets to total assets	0.43		%	0.44		%	0.41		%
ALLL to gross loans	0.74		%	0.73		%	0.75		%
CAPITAL RATIOS ⁽¹⁾
Shareholders' equity to assets	11.87		%	11.20		%	10.62		%
Tier 1 leverage	9.09		%	8.91		%	8.69		%
Common equity tier 1 capital	12.72		%	12.45		%	12.34		%
Tier 1 risk-based capital	12.72		%	12.45		%	12.34		%
Total risk-based capital	13.41		%	13.12		%	13.01		%

⁽¹⁾ At end of period

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Average Balances, Interest Rates, and Net Interest Income

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



	Three Months Ended
	March 31, 2020							December 31, 2019							March 31, 2019
	Average Balance			Tax Equivalent Interest		Average Yield / Rate		Average Balance			Tax Equivalent Interest		Average Yield / Rate		Average Balance			Tax Equivalent Interest		Average Yield / Rate
INTEREST EARNING ASSETS
Loans	$	1,168,070		$	13,254	4.54	%	$	1,184,449		$	13,694	4.62	%	$	1,131,093		$	12,891	4.56	%
Taxable investment securities	251,797			1,489		2.37	%	269,691			1,663		2.47	%	319,962			1,958		2.45	%
Nontaxable investment securities	152,368			1,418		3.72	%	160,022			1,513		3.78	%	179,887			1,687		3.75	%
Fed funds sold	—			—		—	%	11			—		1.46	%	26			—		—	%
Other	90,297			405		1.79	%	55,471			375		2.70	%	40,809			379		3.71	%
Total earning assets	1,662,532			16,566		3.99	%	1,669,644			17,245		4.13	%	1,671,777			16,915		4.05	%
NONEARNING ASSETS
Allowance for loan losses	(7,968		)					(8,205		)					(8,406		)
Cash and demand deposits due from banks	21,556							20,838							19,194
Premises and equipment	26,252							26,377							27,710
Accrued income and other assets	110,786							113,383							99,758
Total assets	$	1,813,158						$	1,822,037						$	1,810,033
INTEREST BEARING LIABILITIES
Interest bearing demand deposits	$	235,161		$	83	0.14	%	$	221,924		$	78	0.14	%	$	236,074		$	68	0.12	%
Savings deposits	426,634			634		0.59	%	417,623			727		0.70	%	381,134			615		0.65	%
Time deposits	404,717			2,074		2.05	%	423,177			2,240		2.12	%	436,448			2,035		1.87	%
Borrowed funds	270,648			1,408		2.08	%	276,574			1,447		2.09	%	321,445			1,574		1.96	%
Total interest bearing liabilities	1,337,160			4,199		1.26	%	1,339,298			4,492		1.34	%	1,375,101			4,292		1.25	%
NONINTEREST BEARING LIABILITIES
Demand deposits	246,262							251,596							226,425
Other	14,130							15,359							8,878
Shareholders’ equity	215,606							215,784							199,629
Total liabilities and shareholders’ equity	$	1,813,158						$	1,822,037						$	1,810,033
Net interest income (FTE)				$	12,367						$	12,753						$	12,623
Net yield on interest earning assets (FTE)						2.98	%						3.06	%						3.02	%

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

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Volume and Rate Variance Analysis

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

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

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

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



	Three Months Ended March 31, 2020 Compared to December 31, 2019 Increase (Decrease) Due to									Three Months Ended March 31, 2020 Compared to March 31, 2019 Increase (Decrease) Due to
	Volume			Rate			Net			Volume			Rate			Net
Changes in interest income
Loans	$	(188	)	$	(252	)	$	(440	)	$	420		$	(57	)	$	363
Taxable investment securities	(108		)	(66		)	(174		)	(405		)	(64		)	(469		)
Nontaxable investment securities	(72		)	(23		)	(95		)	(256		)	(13		)	(269		)
Other	184			(154		)	30			293			(267		)	26
Total changes in interest income	(184		)	(495		)	(679		)	52			(401		)	(349		)
Changes in interest expense
Interest bearing demand deposits	5			—			5			—			15			15
Savings deposits	15			(108		)	(93		)	70			(51		)	19
Time deposits	(96		)	(70		)	(166		)	(154		)	193			39
Borrowed funds	(31		)	(8		)	(39		)	(260		)	94			(166		)
Total changes in interest expense	(107		)	(186		)	(293		)	(344		)	251			(93		)
Net change in interest margin (FTE)	$	(77	)	$	(309	)	$	(386	)	$	396		$	(652	)	$	(256	)

The flattening of the yield curve and recent rate reductions placed pressure on our net interest margin, and we experienced a decline in our net yield on interest earning assets. Given the uncertainty in rates and the economic environment as a result of COVID-19, improvement in our net yield on interest earning assets may not occur during the remainder of 2020.



	Average Yield / Rate for the Three-Month Periods Ended:
	March 31 2020		December 31 2019		September 30 2019		June 30 2019		March 31 2019
Total earning assets	3.99	%	4.13	%	4.23	%	4.15	%	4.05	%
Total interest bearing liabilities	1.26	%	1.34	%	1.35	%	1.33	%	1.25	%
Net yield on interest earning assets (FTE)	2.98	%	3.06	%	3.13	%	3.06	%	3.02	%



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

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Allowance for Loan and Lease Losses

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

The following table summarizes our charge-offs, recoveries, provision for loan losses, and ALLL balances as of, and for the:



	Three Months Ended March 31
	2020			2019
ALLL at beginning of period	$	7,939		$	8,375
Charge-offs
Commercial	4			8
Agricultural	16			—
Residential real estate	15			2
Consumer	123			128
Total charge-offs	158			138
Recoveries
Commercial	22			51
Agricultural	33			1
Residential real estate	27			27
Consumer	46			48
Total recoveries	128			127
Net loan charge-offs (recoveries)	30			11
Provision for loan losses	788			34
ALLL at end of period	$	8,697		$	8,398
Net loan charge-offs (recoveries) to average loans outstanding	—		%	—		%

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



	March 31 2020			December 31 2019			September 30 2019			June 30 2019			March 31 2019
Total charge-offs	$	158		$	334		$	143		$	333		$	138
Total recoveries	128			122			82			151			127
Net loan charge-offs (recoveries)	30			212			61			182			11
Net loan charge-offs (recoveries) to average loans outstanding	—		%	0.02		%	0.01		%	0.02		%	—		%
Provision for loan losses	$	788		$	(18	)	$	193		$	(179	)	$	34
Provision for loan losses to average loans outstanding	0.07		%	—		%	0.02		%	(0.02		)%	—		%
ALLL	$	8,697		$	7,939		$	8,169		$	8,037		$	8,398
ALLL as a % of loans at end of period	0.74		%	0.67		%	0.69		%	0.68		%	0.73		%

While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong at March 31, 2020. However, the COVID-19 pandemic has led to the temporary closure of businesses throughout the communities in which we serve, which has also led to increased unemployment. We increased the ALLL during the quarter as a result of increased economic and environmental risk factors, primarily driven by COVID-19. The economic impact from the COVID-19 crisis could pose significant credit risk due to the potential inability of consumer and commercial borrowers to make contractual payments. In late March 2020, we implemented payment programs for borrowers to alleviate the financial

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

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



	March 31 2020			December 31 2019			September 30 2019			June 30 2019			March 31 2019
ALLL
Individually evaluated for impairment	$	1,309		$	1,114		$	1,333		$	1,479		$	1,509
Collectively evaluated for impairment	7,388			6,825			6,836			6,558			6,889
Total	$	8,697		$	7,939		$	8,169		$	8,037		$	8,398
ALLL to gross loans
Individually evaluated for impairment	0.11		%	0.09		%	0.11		%	0.13		%	0.13		%
Collectively evaluated for impairment	0.63		%	0.58		%	0.58		%	0.55		%	0.60		%
Total	0.74		%	0.67		%	0.69		%	0.68		%	0.73		%

The level of the ALLL is appropriate as of March 31, 2020. We closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at an appropriate level.

For further discussion of the allocation of the ALLL, see “Note 4 – Loans and ALLL” of our interim condensed consolidated financial statements.

Loans Past Due and Loans in Nonaccrual Status

Fluctuations in past due and nonaccrual status loans can have a significant impact on the ALLL. To determine the potential impact, and corresponding estimated losses, we analyze our historical loss trends on loans past due greater than 30 days and nonaccrual status loans for indications of additional deterioration.



	Total Past Due and Nonaccrual Loans
	March 31 2020			December 31 2019			September 30 2019			June 30 2019			March 31 2019
Commercial	$	6,180		$	2,477		$	3,175		$	2,243		$	5,299
Agricultural	4,870			4,285			4,800			6,672			6,854
Residential real estate	3,426			4,572			1,999			1,690			6,063
Consumer	366			71			162			94			152
Total	$	14,842		$	11,405		$	10,136		$	10,699		$	18,368
Total past due and nonaccrual loans to gross loans	1.26		%	0.96		%	0.85		%	0.91		%	1.60		%

Past due and nonaccrual status loans increased in 2020 primarily as a result of deterioration in credit quality for a small number of commercial loans. The increase did not result from the economic impact of COVID-19 or any other apparent factor. As such, we do not believe this activity to be indicative of a trend in past due levels.

We have implemented payment programs for borrowers to alleviate the financial setback due to the temporary closure of businesses and lost wages. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.

A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual status loans by type, is included in “Note 4 – Loans and ALLL” of our interim condensed consolidated financial statements.

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Troubled Debt Restructurings

We have taken a proactive approach to avoid foreclosures on borrowers who are willing to work with us in modifying their loans, thus making them more collectible. This approach has permitted certain borrowers to accept a payment structure that will allow them to continue making payments in lieu of foreclosure. The modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. The majority of modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed in nonaccrual status may be placed back on accrual status after six months of continued performance and achievement of current payment status.

We restructure debt with borrowers who, due to financial difficulties, are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, allow interest only payment structures, forgive principal, forgive interest, or grant a combination of these modifications. Typically, the modifications are for a period of three years or less. There were no TDRs that were government sponsored as of March 31, 2020 or December 31, 2019.

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

The following tables provide roll-forwards of TDRs for the:



	Three Months Ended March 31, 2020
	Accruing Interest					Nonaccrual					Total
	Number of Loans		Balance			Number of Loans		Balance			Number of Loans		Balance
January 1, 2020	122		$	21,194		9		$	3,543		131		$	24,737
New modifications	5		1,156			1		493			6		1,649
Principal advances (payments)	—		(984		)	—		(106		)	—		(1,090		)
Loans paid off	(13	)	(1,098		)	—		—			(13	)	(1,098		)
Transfers to OREO	—		—			(1	)	(81		)	(1	)	(81		)
March 31, 2020	114		$	20,268		9		$	3,849		123		$	24,117



	Three Months Ended March 31, 2019
	Accruing Interest					Nonaccrual					Total
	Number of Loans		Balance			Number of Loans		Balance			Number of Loans		Balance
January 1, 2019	133		$	23,400		28		$	3,551		161		$	26,951
New modifications	3		670			—		—			3		670
Principal advances (payments)	—		(340		)	—		(127		)	—		(467		)
Loans paid off	(6	)	(799		)	(3	)	(177		)	(9	)	(976		)
Transfers to OREO	—		—			(1	)	(48		)	(1	)	(48		)
Transfers to nonaccrual status	(2	)	(626		)	2		626			—		—
March 31, 2019	128		$	22,305		26		$	3,825		154		$	26,130

The following table summarizes our TDRs as of:



	March 31, 2020						December 31, 2019
	Accruing Interest		Nonaccrual		Total		Accruing Interest		Nonaccrual		Total		Total Change
Current	$	19,842	$	493	$	20,335	$	20,847	$	507	$	21,354	$	(1,019	)
Past due 30-59 days	386		104		490		346		—		346		144
Past due 60-89 days	—		—		—		1		—		1		(1		)
Past due 90 days or more	40		3,252		3,292		—		3,036		3,036		256
Total	$	20,268	$	3,849	$	24,117	$	21,194	$	3,543	$	24,737	$	(620	)

Additional disclosures about TDRs are included in “Note 4 – Loans and ALLL” of our interim condensed consolidated financial statements.

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Impaired Loans

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



	March 31, 2020						December 31, 2019
	Recorded Balance		Unpaid Principal Balance		Valuation Allowance		Recorded Balance		Unpaid Principal Balance		Valuation Allowance
TDRs
Commercial real estate	$	5,136	$	5,455	$	66	$	5,325	$	5,643	$	15
Commercial other	1,972		1,972		113		1,156		1,156		—
Agricultural real estate	8,816		8,816		67		9,182		9,181		12
Agricultural other	3,679		3,679		8		4,421		4,421		14
Residential real estate senior liens	4,510		4,792		898		4,641		4,923		922
Home equity lines of credit	4		304		—		12		312		—
Total TDRs	24,117		25,018		1,152		24,737		25,636		963
Other impaired loans
Commercial real estate	151		213		—		153		216		—
Commercial other	1,339		1,339		—		1,231		1,231		—
Agricultural real estate	623		673		3		699		750		—
Agricultural other	542		542		—		538		538		—
Residential real estate senior liens	775		921		154		760		907		151
Home equity lines of credit	85		85		—		73		73		—
Consumer secured	3		3		—		—		—		—
Total other impaired loans	3,518		3,776		157		3,454		3,715		151
Total impaired loans	$	27,635	$	28,794	$	1,309	$	28,191	$	29,351	$	1,114

We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recognition of a charge-off.

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

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Nonperforming Assets

The following table summarizes our nonperforming assets as of:



	March 31 2020			December 31 2019			September 30 2019			June 30 2019			March 31 2019
Nonaccrual status loans	$	6,913		$	6,535		$	6,962		$	8,107		$	7,260
Accruing loans past due 90 days or more	40			—			40			110			30
Total nonperforming loans	6,953			6,535			7,002			8,217			7,290
Foreclosed assets	564			456			468			513			401
Debt securities	230			230			230			230			230
Total nonperforming assets	$	7,747		$	7,221		$	7,700		$	8,960		$	7,921
Nonperforming loans as a % of total loans	0.59		%	0.55		%	0.59		%	0.70		%	0.64		%
Nonperforming assets as a % of total assets	0.43		%	0.40		%	0.42		%	0.49		%	0.44		%

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

The following table summarizes nonaccrual loans as of:



	March 31 2020		December 31 2019		September 30 2019		June 30 2019		March 31 2019
Commercial	$	1,643	$	1,621	$	1,632	$	1,692	$	1,931
Agricultural	4,606		4,285		4,520		5,532		4,757
Residential real estate	661		629		810		883		572
Consumer	3		—		—		—		—
Total	$	6,913	$	6,535	$	6,962	$	8,107	$	7,260

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



	March 31 2020		December 31 2019		September 30 2019		June 30 2019		March 31 2019
Commercial	$	304	$	390	$	390	$	450	$	515
Agricultural	3,441		3,048		3,309		5,096		3,199
Residential real estate	104		105		107		109		111
Total	$	3,849	$	3,543	$	3,806	$	5,655	$	3,825

Additional disclosures about nonaccrual status loans are included in “Note 4 – Loans and ALLL” of our interim condensed consolidated financial statements.

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Noninterest Income and Noninterest Expenses

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



	Three Months Ended March 31
						Change
	2020			2019		$			%
Service charges and fees
ATM and debit card fees	$	794		$	685	$	109		15.91	%
Service charges and fees on deposit accounts	587			530		57			10.75	%
Freddie Mac servicing fee	159			150		9			6.00	%
Net OMSR income (loss)	(261		)	12		(273		)	N/M
Other fees for customer services	74			84		(10		)	(11.90	)%
Total service charges and fees	1,353			1,461		(108		)	(7.39	)%
Investment and trust advisory fees	572			677		(105		)	(15.51	)%
Gains from redemption of corporate owned life insurance policies	524			—		524			N/M
Earnings on corporate owned life insurance policies	182			184		(2		)	(1.09	)%
Net gain on sale of mortgage loans	151			93		58			62.37	%
Other
Net gains on sale of AFS securities	71			—		71			N/M
All other	145			75		70			93.33	%
Total other	216			75		141			188.00	%
Total noninterest income	$	2,998		$	2,490	$	508		20.40	%

ATM and debit card fees fluctuate from period to period based primarily on usage of ATM and debit cards. While we do not anticipate significant changes to our ATM and debit card fee structure, we do expect that fee income will continue to increase during the remainder of 2020 as the usage of ATM and debit cards continues to increase.

OMSR income results are driven, in part, by changes in offering rates on residential mortgage loans, anticipated prepayments in the servicing-retained portfolio, and the volume of loans within the servicing-retained portfolio. Increased prepayment speeds, as a result of a decline in interest rates, were the primary driver of the losses recognized during the first quarter. Income during 2020 could experience fluctuations and could vary from 2019 levels.

The decrease in investment and trust advisory fees was driven by a reduction in trust-related assets, which resulted significantly from a decline in the stock market during the first quarter of 2020. With the uncertainty in the stock market as a result of COVID-19, investment and trust advisory fees during the remainder of 2020 may not exceed 2019 levels.

We recognized a gain during the first quarter of 2020 due to the redemption of a corporate owned life insurance policy in connection with the passing of a retired executive officer.

Net gain on sale of mortgage loans fluctuates primarily as the result of a change in the amount of loans sold. The amount of loans sold can fluctuate based on balance sheet management strategies. As such, net gain on sale of mortgage loans will continue to fluctuate in comparison to 2019 during the remainder of 2020.

We are continually analyzing our AFS securities portfolio for potential sale opportunities. Securities with unrealized gains or less than desirable yields may be sold for funding and profitability purposes. During the first quarter of 2020, we identified $26,855 in securities that were desirable to be sold and recognized net gains of $71 with these sales. We anticipate taking this same approach of analyzing our AFS securities portfolio for potential sale opportunities during the remainder of 2020.

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

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



	Three Months Ended March 31
					Change
	2020		2019		$			%
Compensation and benefits	$	5,869	$	5,722	$	147		2.57	%
Furniture and equipment	1,461		1,494		(33		)	(2.21	)%
Occupancy	867		930		(63		)	(6.77	)%
Other
Audit, consulting, and legal fees	433		453		(20		)	(4.42	)%
Donations and community relations	330		140		190			135.71	%
ATM and debit card fees	323		248		75			30.24	%
Marketing costs	203		142		61			42.96	%
Memberships and subscriptions	199		167		32			19.16	%
Director fees	182		207		(25		)	(12.08	)%
Loan underwriting fees	166		316		(150		)	(47.47	)%
FDIC insurance premiums	156		170		(14		)	(8.24	)%
Postage and freight	131		129		2			1.55	%
Education and travel	91		157		(66		)	(42.04	)%
All other	534		525		9			1.71	%
Total other noninterest expenses	2,748		2,654		94			3.54	%
Total noninterest expenses	$	10,945	$	10,800	$	145		1.34	%

Donations and community relations increased during 2020 as a result of initiatives designed to deepen and strengthen our relationship with the communities in which we operate and serve which includes an expanded footprint. In addition to providing monetary contributions, some of these initiatives include volunteering our time, which is not a component of donations and community relations costs. While these discretionary contributions incurred in 2020 resulted in increased expenses, donations and community relations during the remainder of 2020 are not expected to exceed 2019 levels.

Loan underwriting fees were higher during the first quarter of 2019 as a result of new loan products, including first time home buyer and down payment assistance programs, that are no longer offered. Loan underwriting fees during 2020 are not expected to exceed 2019 levels.

Education and travel expenses fluctuate based on the timing of trainings and seminars. Beginning in mid-March of 2020, travel declined due to COVID-19 and recommendations by the Center for Disease Control to limit in-person gatherings. With the recent stay-at-home order in the State of Michigan due to COVID-19, education and travel expenses during the remainder of 2020 may decline in comparison to 2019 levels.

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

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Analysis of Changes in Financial Condition



	March 31 2020		December 31 2019		$ Change			% Change (unannualized)
ASSETS
Cash and cash equivalents	$	96,751	$	60,572	$	36,179		59.73	%
AFS securities
Amortized cost of AFS securities	395,090		423,980		(28,890		)	(6.81	)%
Unrealized gains (losses) on AFS securities	12,099		5,859		6,240			106.50	%
AFS securities	407,189		429,839		(22,650		)	(5.27	)%
Mortgage loans AFS	1,228		904		324			35.84	%
Loans
Gross loans	1,175,936		1,186,570		(10,634		)	(0.90	)%
Less allowance for loan and lease losses	8,697		7,939		758			9.55	%
Net loans	1,167,239		1,178,631		(11,392		)	(0.97	)%
Premises and equipment	25,946		26,242		(296		)	(1.13	)%
Corporate owned life insurance policies	27,691		28,455		(764		)	(2.68	)%
Accrued interest receivable	7,022		6,501		521			8.01	%
Equity securities without readily determinable fair values	21,535		21,629		(94		)	(0.43	)%
Goodwill and other intangible assets	48,366		48,379		(13		)	(0.03	)%
Other assets	12,937		13,046		(109		)	(0.84	)%
TOTAL ASSETS	$	1,815,904	$	1,814,198	$	1,706		0.09	%
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits	$	1,322,083	$	1,313,851	$	8,232		0.63	%
Borrowed funds	263,171		275,999		(12,828		)	(4.65	)%
Accrued interest payable and other liabilities	15,152		14,166		986			6.96	%
Total liabilities	1,600,406		1,604,016		(3,610		)	(0.23	)%
Shareholders’ equity	215,498		210,182		5,316			2.53	%
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,815,904	$	1,814,198	$	1,706		0.09	%

As shown above, total assets were relatively unchanged from December 31, 2019. Cash and cash equivalents increased as a result of the sale of AFS securities and an increase in customer deposits during the first quarter of 2020. We experienced a $10,634 decrease in loans during the first three months of 2020 which was largely driven by a decline in our agricultural loan portfolio.

The following table outlines the changes in loan balances:



	March 31 2020		December 31 2019		$ Change			% Change (unannualized)
Commercial	$	695,278	$	700,941	$	(5,663	)	(0.81	)%
Agricultural	108,856		116,920		(8,064		)	(6.90	)%
Residential real estate	302,016		298,569		3,447			1.15	%
Consumer	69,786		70,140		(354		)	(0.50	)%
Total	$	1,175,936	$	1,186,570	$	(10,634	)	(0.90	)%

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The following table displays loan balances as of:



	March 31 2020		December 31 2019		September 30 2019		June 30 2019		March 31 2019
Commercial	$	695,278	$	700,941	$	708,735	$	701,954	$	677,554
Agricultural	108,856		116,920		118,460		120,363		123,393
Residential real estate	302,016		298,569		292,311		283,285		276,776
Consumer	69,786		70,140		72,298		71,020		67,109
Total	$	1,175,936	$	1,186,570	$	1,191,804	$	1,176,622	$	1,144,832

The competition for commercial loan opportunities continues to be strong in the current interest rate environment. While we experienced a decline in this segment of the portfolio during the first quarter, we expect growth in the commercial loan portfolio during the remainder of 2020 due to our participation in the SBA PPP, in addition to continuing to provide attractive and competitive loan products. During the first quarter of 2020, and over the past 12 months, agricultural loans have declined. Residential real estate and consumer loans experienced growth over the past year and continued growth is expected during the remainder of 2020.

The following table outlines the changes in deposit balances:



	March 31 2020		December 31 2019		$ Change			% Change (unannualized)
Noninterest bearing demand deposits	$	249,424	$	249,152	$	272		0.11	%
Interest bearing demand deposits	237,392		229,865		7,527			3.27	%
Savings deposits	435,207		427,215		7,992			1.87	%
Certificates of deposit	358,534		365,049		(6,515		)	(1.78	)%
Brokered certificates of deposit	27,458		27,458		—			—	%
Internet certificates of deposit	14,068		15,112		(1,044		)	(6.91	)%
Total	$	1,322,083	$	1,313,851	$	8,232		0.63	%

The following table displays deposit balances as of:



	March 31 2020		December 31 2019		September 30 2019		June 30 2019		March 31 2019
Noninterest bearing demand deposits	$	249,424	$	249,152	$	242,179	$	244,240	$	229,865
Interest bearing demand deposits	237,392		229,865		230,579		228,704		236,997
Savings deposits	435,207		427,215		409,930		378,988		385,617
Certificates of deposit	358,534		365,049		357,984		359,945		361,716
Brokered certificates of deposit	27,458		27,458		52,744		57,773		50,273
Internet certificates of deposit	14,068		15,112		15,357		11,768		13,495
Total	$	1,322,083	$	1,313,851	$	1,308,773	$	1,281,418	$	1,277,963

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

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



	March 31 2020		December 31 2019		September 30 2019		June 30 2019		March 31 2019
Government sponsored enterprises	$	—	$	—	$	—	$	160	$	165
States and political subdivisions	163,116		169,752		175,575		176,742		191,266
Auction rate money market preferred	2,726		3,119		3,089		2,849		2,819
Mortgage-backed securities	126,554		140,204		150,120		173,340		181,138
Collateralized mortgage obligations	114,793		116,764		116,745		117,358		119,454
Total	$	407,189	$	429,839	$	445,529	$	470,449	$	494,842

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



	March 31 2020		December 31 2019		September 30 2019		June 30 2019		March 31 2019
FHLB advances	$	235,000	$	245,000	$	245,000	$	295,000	$	280,000
Securities sold under agreements to repurchase without stated maturity dates	28,171		30,999		32,386		25,462		29,824
Federal funds purchased	—		—		—		—		1,860
Total	$	263,171	$	275,999	$	277,386	$	320,462	$	311,684

Contractual Obligations and Loan Commitments

We have various financial obligations, including contractual obligations and commitments related to deposits and borrowings, which may require future cash payments. We also have loan related commitments that may impact liquidity. The commitments include unused lines of credit, commercial and standby letters of credit, and commitments to grant loans. These commitments to grant loans include residential mortgage loans with the majority committed to be sold to the secondary market. Many of these commitments historically have expired without being drawn upon and do not necessarily represent our future cash requirements.

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

Our exposure to credit-related loss in the event of nonperformance by the counter parties to the financial instruments for commitments to extend credit and standby letters of credit could be up to the contractual notional amount of those instruments. We use the same credit policies as we do for extending loans to customers. No significant losses are anticipated as a result of these commitments.

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Capital

Capital consists solely of common stock, retained earnings, and accumulated other comprehensive income (loss). We are authorized to raise capital through dividend reinvestment, employee and director stock purchases, and shareholder stock purchases. Pursuant to these authorizations, we issued 69,907 shares or $1,330 of common stock during the first three months of 2020, as compared to 61,405 shares or $1,433 of common stock during the same period in 2019. We also offer the Directors Plan in which participants purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $123 and $131 during the three-month periods ended March 31, 2020 and March 31, 2019, respectively.

We have publicly announced a common stock repurchase plan. Pursuant to this plan, we repurchased 59,420 shares or $1,168 of common stock during the first three months of 2020 and 26,296 shares or $632 during the first three months of 2019. As of March 31, 2020, we were authorized to repurchase up to an additional 188,486 shares of common stock.

The FRB has established minimum risk based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital.

The common equity tier 1 capital ratio has a minimum requirement of 4.50%. The minimum standard for primary, or Tier 1 capital is 6.00% and the minimum standard for total capital is 8.00%. The minimum requirements presented below include the minimum required capital levels based on the Basel III Capital Rules. Capital requirements to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. The following table sets forth these requirements and our ratios as of:



	March 31, 2020						December 31, 2019
	Actual		Minimum Required - BASEL III		Required to be Considered Well Capitalized		Actual		Minimum Required - BASEL III		Required to be Considered Well Capitalized
Common equity tier 1 capital	12.72	%	7.00	%	6.50	%	12.56	%	7.000	%	6.50	%
Tier 1 capital	12.72	%	8.50	%	8.00	%	12.56	%	8.500	%	8.00	%
Total capital	13.41	%	10.50	%	10.00	%	13.18	%	10.500	%	10.00	%
Tier 1 leverage	9.09	%	4.00	%	5.00	%	9.01	%	4.00	%	5.00	%

There are no significant regulatory constraints placed on our capital. At March 31, 2020, the Bank exceeded minimum capital requirements.

Liquidity

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

Our primary sources of liquidity are cash and cash equivalents and unencumbered AFS securities. These categories totaled $310,622 or 17.11% of assets as of March 31, 2020, compared to $291,190 or 16.05% as of December 31, 2019. The increase in the amount and percentage of primary liquidity is a direct result of an increase in market deposits and a deliberate reduction in non-market funding which required collateralization. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Based on these same factors, daily liquidity could vary significantly.

Deposit accounts are our primary source of funds. Our secondary sources include the ability to borrow from the FHLB, from the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. In recent periods, we have elected to use excess funds and proceeds from the sale of AFS securities to reduce borrowings and other higher-cost funding sources. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As of March 31, 2020, we had available lines of credit of $140,121.

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



	March 31 2020
Total cash and cash equivalents	$	96,751
Available lines of credit
Fed funds lines with correspondent banks	93,000
FHLB borrowings	30,319
FRB Discount Window	11,802
Other lines of credit	5,000
Total available lines of credit	140,121
Unencumbered lendable value of FRB collateral, estimated¹	170,000
Total cash and liquidity	$	406,872


⁽¹⁾	Includes estimated unencumbered lendable value of FHLB collateral of $120,000

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



	2020			2019			$ Variance
Net cash provided by (used in) operating activities	$	3,394		$	3,076		$	318
Net cash provided by (used in) investing activities	39,991			(11,095		)	51,086
Net cash provided by (used in) financing activities	(7,206		)	(44,773		)	37,567
Increase (decrease) in cash and cash equivalents	36,179			(52,792		)	88,971
Cash and cash equivalents January 1	60,572			73,471			(12,899		)
Cash and cash equivalents March 31	$	96,751		$	20,679		$	76,072

Fair Value

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

For further information regarding fair value measurements see “Note 10 – Fair Value” of our interim condensed consolidated financial statements.

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Market Risk

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

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

The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield curves, interest rate relationships, loan prepayments, and funding sources. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic rate environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits.

Gap analysis, the secondary method to measure IRR, measures the cash flows and/or the earliest repricing of our interest bearing assets and liabilities. This analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the embedded repricing options contained in assets and liabilities. Residential real estate and consumer loans allow the borrower to repay the balance prior to maturity without penalty, while commercial and agricultural loans may have prepayment penalties. The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current offering rates, the level of home sales, and the overall availability of credit in the market place. Generally, a decrease in interest rates will result in an increase in cash flows from these assets. A significant portion of our securities are callable or have prepayment options. The call and prepayment options are more likely to be exercised in a period of decreasing interest rates. Savings and demand accounts may generally be withdrawn on request without prior notice. The timing of cash flows from these deposits is estimated based on historical experience. Certificates of deposit have penalties that discourage early withdrawals.

Our primary market risk exposure with the onset of the COVID-19 crisis is uncertain. A review of our market risk methods are ongoing and modeling is incorporating additional assumptions to account for this uncertainty related to this crisis. Repricing, cash flows, and prepayment projections for loans and mortgage-backed securities are not expected to behave as they would be expected to in a more stable interest rate environment. SBA PPP loans and FRB PPP Lending Facility borrowings are new instruments and have payment characteristics that are still uncertain. In late March 2020, we implemented loan payment programs for customers to alleviate the financial setback caused by the temporary closure of businesses and lost wages. Under these programs, borrowers who were in good standing as of March 1, 2020 can elect to defer full or partial payments for a 90-day period. Our expectations regarding loan payments after the 90-day period is uncertain. Customer deposit flows may experience unusual fluctuations due to government support programs, customer and business stress, and general money supply. We continue to closely monitor customer and economic indicators to develop more precise market risk assumptions as the economic impact of this crisis begins to reveal itself.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

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

Item 4. Controls and Procedures.

DISCLOSURE CONTROLS AND PROCEDURES

We carried out an evaluation, under the supervision and with the participation of the Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15(d)-15(e) under the Exchange Act) as of March 31, 2020, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as of March 31, 2020, were effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

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

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

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

Item 1A. Risk Factors.

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

The pandemic has created significant market volatility, economic uncertainty, and disruption to normal business operations around the world, with slowdowns and shutdowns affecting entire industries. The Michigan governor issued on March 23, 2020 a stay-at-home order, which limits gatherings and travel, and requires workers who are not necessary to sustain or protect life to stay home. The Michigan stay-at-home order has since been extended to May 15. The orders have led to financial stress for many businesses and workers throughout the communities we serve.

The extent to which COVID-19 impacts our business will depend on future developments, which are highly uncertain and cannot be predicted. Future developments include new information which may emerge concerning the severity of COVID-19 and the actions to contain the coronavirus or treat its impact, among others. We expect the significance of the COVID-19 pandemic, including the extent of its effect on our financial and operational results, to be dictated by, among other factors, its duration, the success of efforts to contain it and the impact of actions taken in response. Uncertainty created by the COVID-19 pandemic is pervasive, and the pandemic will likely impact our operations, customers, vendors and various areas of risk. Other areas of risk include, but are not limited to, cybersecurity, credit, interest rate, litigation and risk related to vendor services. With the uncertainty created by COVID-19, we are not able at this time to estimate the impact of the COVID-19 pandemic on our ongoing financial and operational results.

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


(A)	None


(B)	None


(C)	Repurchases of Common Stock

We have adopted and publicly announced a common stock repurchase plan. The plan was last amended on December 23, 2019, to allow for the repurchase of an additional 250,000 shares of common stock after that date. These authorizations do not have expiration dates. As common shares are repurchased under this plan, they are retired and revert back to the status of authorized, but unissued common shares.

The following table provides information for the three-month period ended March 31, 2020, with respect to this plan:



	Common Shares Repurchased			Total Number of Common Shares Purchased as Part of Publicly Announced Plan or Program	Maximum Number of Common Shares That May Yet Be Purchased Under the Plans or Programs
	Number	Average Price Per Common Share
Balance, December 31					247,906
January 1 - 31	3,973	$	24.16	3,973	243,933
February 1 - 29	3,322	24.08		3,322	240,611
March 1 -31	52,125	19.01		52,125	188,486
Balance, March 31	59,420	$	19.64	59,420	188,486

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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

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

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

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

101.1*		101.INS (XBRL Instance Document)

		101.SCH (XBRL Taxonomy Extension Schema Document)

		101.CAL (XBRL Calculation Linkbase Document)

		101.LAB (XBRL Taxonomy Label Linkbase Document)

		101.DEF (XBRL Taxonomy Linkbase Document)

		101.PRE (XBRL Taxonomy Presentation Linkbase Document)

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

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SIGNATURES

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



		Isabella Bank Corporation

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

Date:	April 29, 2020		/s/ Neil M. McDonnell
			Neil M. McDonnell
			Chief Financial Officer
			(Principal Financial Officer)